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What Is a Blue Chip Stock?
A blue chip stock is a huge company with an excellent reputation. These are typically large, well-established, and financially sound companies that have operated for many years and that have dependable earnings, often paying dividends to investors. A blue chip stock typically has a market capitalization in the billions, is generally the market leader or among the top three companies in its sector, and is more often than not a household name. For all of these reasons, blue chip stocks are among the most popular to buy among investors. Some examples of blue chip stocks are IBM Corp., Coca-Cola Co., and Boeing Co.
Features of Blue-chip Stocks
The features of Blue-chip stocks are enlisted below –
- Assured returns: Blue-chip stocks generate returns quarterly in the form of dividends. The fact that companies that are well-established also serve as a safe investment avenue for most investors. With this safety comes the assurance of earning steady but guaranteed returns.
- Risk factor: Since big companies with stable financial performance issue these stocks, the risks factor associated with blue-chip companies are comparatively less. Investors can further reduce the burden of risk associated with blue-chip shares by diversifying their investment portfolio.
- Investment horizon: The term of investment is usually over 7 years. Such extended term makes Blue-chip suitable for achieving long-term financial goals owing to its long investment horizon.
- Growth prospect: Blue-chip companies are those large companies that have reached their maximum growth potential. This influences the Blue-chip shares who undergo slow but steady growth over time.
- Taxation: The gains generated through blue-chip shares in India are treated as income under Section 80 C of the Income Tax Act. The short-term capital gains are subjected to taxation at the rate of 15%. However, the long-term capital gains exceeding Rs. 1 Lakh are subjected to taxation at the rate of 10%.
Major Advantages of Investing In Blue-Chip Stocks
The strong financial standing, excellent market valuation and credit worthiness of blue-chip stocks act in favour of their investors and extend multiple benefits to them.
Blue-chip stocks investors would avail these following advantages –
- Stable and regular dividends: Irrespective of the market conditions, blue-chip stock investors avail stable returns on their investments. Such returns are generated in the form of divided which are extended to them quarterly.
- Opportunity to achieve financial goals: Being a long-term investment option that comes with an investment horizon of over 7 years. It gives investors ample time to build a healthy corpus over the years for their respective financial goals.
- Advantage of portfolio diversification: Blue-stock companies are high-profile business organisations who do not generate revenue from just one channel. It not only allows them to cushion their losses against operational setbacks but also allows their investors to spread out the associated risks of blue-stock shares.
- Liquidity: Blue-chip companies enjoy market goodwill and high creditworthiness. It directly enhances the market value of blue-chip stocks and makes them an attractive investment option for investors. This directly facilitates the purchase and sale of such stocks making the liquid in nature.
Reasons to Invest In Blue-Chip Stocks
Blue-chip stocks in India are considered to be a desirable investment option for achieving long-term financial goals.
Here are a few reasons to invest in Blue-chip shares –
- It offers higher returns that are paid quarterly.
- Facilitates corpus building.
- Facilitates portfolio diversification.
- Cushions the impact of the recession, inflation and economic stagnation.
However, owing to their higher price, blue-chip shares may not be suitable for small investors.
Who should invest in blue-chip stocks?
Blue-chip stocks are those stocks that offer consistent returns and have minimum risk attached. Such stocks are ideal for those investors who want secure returns. It is a good source of investment for all such investors who do not want to let their investment be affected due to market volatility.
Understanding a Blue Chip Stock
While dividend payments are not absolutely necessary for a stock to be considered a blue chip, most blue chips have long records of paying stable or rising dividends. The term is believed to have been derived from poker, where blue chips are the most expensive chips.
A blue chip stock is generally a component of the most reputable market indexes or averages, such as the Dow Jones Industrial Average, the Standard & Poor’s (S&P) 500, and the Nasdaq-100 in the United States, the TSX-60 in Canada, or the FTSE Index in the United Kingdom.
How big a company needs to be to qualify for blue chip status is open to debate. A generally accepted benchmark is a market capitalization of $5 billion, although market or sector leaders can be companies of all sizes. The T. Rowe Price Blue Chip Growth Fund doesn’t have a specific guideline for what type of company qualifies outside of focusing on large-cap and mid-cap companies that are well-established in their industries, although the median market cap of the fund’s holdings has historically been in the range of close to $100 billion.
The Safety of Blue Chip Stocks
While a blue chip company may have survived several challenges and market cycles, leading to it being perceived as a safe investment, this may not always be the case. The bankruptcies of General Motors and Lehman Brothers, as well as a number of leading European banks during the global recession of 2008, are proof that even the best companies may struggle during periods of extreme stress.
Blue Chips as Part of a Larger Portfolio
While blue chip stocks are appropriate for use as core holdings within a larger portfolio, they generally shouldn’t be the entire portfolio. A diversified portfolio usually contains some allocation to bonds and cash. Within a portfolio’s allocation to stocks, an investor should consider owning mid-caps and small-caps as well. Younger investors can generally tolerate the risk that comes from having a greater percentage of their portfolios in stocks, including blue chips, while older investors may choose to focus more on capital preservation through larger investments in bonds and cash.
Blue chip stocks are the titans of their sectors—industry-defining companies that are well-known, well-capitalized, long-term stable plays with solid financial prospects.
Many of the largest companies in the S&P 500 or the Dow 30, such as IBM, JPMorgan Chase, or Walmart.
The term “blue chip stock” comes from the world of poker, where chips used in gambling have different colors to represent different dollar amounts. A blue chip is typically the one with the highest value of all, surpassing white chips and red chips.
A diversified portfolio might include the ownership of a rash of blue-chip stocks, meaning the stocks of large, well-capitalized, well-understood companies, among a variety of other holdings. In addition to owning individual stocks, investors may also seek to have blue-chip exposure through the purchase of mutual funds or exchange-traded funds (ETFs).
A market participant can buy blue chip stocks individually, or by buying mutual funds or exchange-traded funds (ETFs) that invest in blue-chip stocks. In some cases, funds and ETFs will hold a variety of stocks and asset classes, including blue chips. In other cases, the funds or ETFs might be focused exclusively on blue chips, such as an ETF that tracks the Dow Jones Industrial Average, which comprises 30 of the largest blue chip stocks.