Blue-Chip Stocks: 9 Reasons Why You Need Them in Your Portfolio

Blue-chip stocks are like Ivy League investment stocks. They are shares of companies known for steady cash flow, solid balance sheets, reliable business structure, and excellent performance history. Like Coca-Cola or Nestle, these underlying companies are household names that have stood the test of time.

Their excellent performance and track records over time make blue-chip stocks some of the most secure investments. They should form a part of your diversified portfolio to help balance the possible losses in market downturns. But before we dive into that, let's have a quick overview of blue-chip stocks.

What Are Blue-Chip Stocks?

Blue-chip stocks are shares of long-standing companies that are well-established, big, financially stable, leaders in their sector, and well-known. Like blue-chips in poker games, from which the name is derived, blue-chip companies are highly valued.

They are known for strong financials, steady dividends, and cash flow – characteristics long-term investors seek.

The benefits of having blue-chip stocks as part of your portfolio include steady dividend payout, dividend growth, lower volatility, and fairly predictable growth.

Seasoned investors consider them to be relatively safer than other stocks. Hence, they will make a valuable addition to your portfolio, especially in times of market uncertainties.

However, it's vital that you pick the right blue-chip stocks as not all of them will meet the required expectations. The idea is to focus on the real valuation of the company and steer clear of overvalued stocks.

Don't be discouraged by the fact that blue-chip stocks aren't fast-growing. Be more concerned with the consistent gains over the long term plus the greater stability.

Although there are no set standard criteria for which stocks are considered blue-chip, they possess some identifying characteristics that set them apart.

Blue-chip companies have the following in common:

• Stability:  These companies are typically decades old and have shown considerable earning consistency over that period.
• Consistency: They are also dividend stocks that show consistent dividend payments over time. They also tend to grow dividends paid per share at a steady rate. Returns on capital as well as returns on equity are also consistent.
• Competitive advantage: Their reputation and cost efficiency due to size give them an edge. These companies can borrow money at a much lower cost than competitors because of their solid balance sheet and assets. Their products and services are high-quality and diversified across multiple geographic locations, which gives them resiliency.
• Benchmark Indices' Components: Blue chip companies are usually part of benchmark indices like The Dow Jones Industrial Average, the S&P 500, Nifty 50, Sensex, etc. Benchmark indices are a group of securities or stocks used to measure how well or poorly other stocks or securities performed in the market.

Real-life examples of blue-chip stocks include Nestle, Coca-Cola, Proctor and Gamble, Shell, McDonald's, and Amazon. These companies are also on the Fortune 500 list.

Now that you have a firm grasp of what a blue-chip stock is, let's proceed with why it makes sense to have shares of profitable and well-recognized companies in your portfolio.

Why You Should Have Blue-Chip Stocks in Your Portfolio

Incorporating blue-chip stocks into your meticulously diversified investment portfolio is a prudent decision with the potential for long-term rewards. Although these stocks often come with a higher price tag, the benefits they offer make them a valuable addition.

Let's explore why blue-chip stocks are considered a worthwhile investment choice.

1. Safe Dividends

As a dividend investor, your top priority is the reliability of those cherished dividend payments – the regular share of a company's earnings that keeps your investment journey on a smooth course. After all, if those dividends were to dry up, you'd be left in uncharted waters, no longer a dividend investor. These dividends are like a tasty slice of a company's profits, served to shareholders on a quarterly basis.

Now, it's worth noting that smaller companies and ambitious startups usually retain their earnings to fuel further growth and expansion. They might not serve up dividends yet but don't fret, as they often flip the script once they reach a certain size and find fewer opportunities for in-house investments.

But when it comes to the big players, the blue-chip stocks, well, they're the stars of the show when it comes to consistent, steadily growing dividend payouts. No matter how turbulent the daily stock market seas get, you, the investor, can enjoy a steady stream of portfolio income.

Here's another nifty aspect of dividends – like your trusty hedge against inflation. As the cost of living creeps upward, your dividends often follow suit, helping you maintain your financial footing.

You see, these blue-chip giants aren't just handing out dividends willy-nilly. They have solid financial foundations that make your dividend income a safe and reliable bet. Their track record of unwavering payments and steady growth builds trust among investors and that trust? It's your ticket to long-term wealth building.

So, while the market may have ups and downs, your dividend income remains a constant source of financial security.

2. High Returns on Investment

Historically, blue-chip stocks have performed better than the general stock market, which averages 8% to 10% return. Blue-chip stocks can return up to 12% when you ideally reinvest your dividends.

It's best you automatically reinvest your dividend and returns. This means that you'll earn interest on your interest, making your stock portfolio grow even faster.

3. Safe Harbor Stocks

Blue-chip stocks are like the reliable lighthouses of the stock market – they provide a steady beacon of stability amid the choppy seas of investment. Compared to the tumultuous waters of penny stocks and smaller company shares, blue-chip stocks offer a smoother ride. They also have a knack for bouncing back swiftly after the occasional market tempest.

Now, don't get us wrong, blue-chip stocks aren't invincible. When the entire market goes on a rollercoaster ride, they might dip a bit. However, they're the dependable assets of your portfolio.

These stocks are tailor-made for the “buy and hold” strategy. In fact, the longer you keep them, even when the stock market becomes turbulent. In a volatile market, these stocks offer an extra layer of security for your portfolio, like a trusty lifeboat ready to keep you afloat in rough financial seas. So, when you're looking to build a resilient and fruitful investment portfolio, you can count on blue-chip stocks as your steadfast anchors of stability.

4. Brand Recognition

Blue-chip stocks are like the rock stars of the stock market – they're the household names everyone knows and loves. That means you get the added perk of following their progress through your favorite news outlets. 

And here's where it gets fun – as an investor, you can get a kick out of supporting the companies you're invested in. Imagine strolling into a Shell gas station to fill your tank or sipping that refreshing Nestle bottled water.

It's like saying, “Hey, I own a piece of this pie!” So, not only are you watching your investments grow, but you're also enjoying the products and services of the companies you believe in. It's a win-win situation, and it's all part of the blue-chip stock experience.

5. Liquidity and Ease of Access

Because they are popular, blue-chip stocks are easy to buy and sell. You will appreciate this benefit more when you try to sell unpopular stocks. It can be frustrating trying to offload less popular investments when their value starts to drop or when you want to release some of your equity.

Blue-chip stocks are some of the most liquid investments in the world. You can trade them immediately through various brokers, fund managers, or online platforms.

6. Diversification

Blue-chip companies are typically diversified along product lines, demographics, and location. Take British Petroleum, for instance. It's an Oil and Gas company, but it also owns convenience stores in the US and gas stations. It also owns the Wild Bean Coffee company headquartered in the UK. Therefore, the company straddles the consumer and retail markets and the commodities market.

This shows that a blue-chip investment can help to diversify as much as investing in 3 or more small growth and value stocks. And it will only cost you one transaction fee. Diversification ensures the company is resilient and won't go out of business when one of its product lines or target market goes down.

7.  Diversified Portfolio

When you invest in blue-chip companies, you secure a part of your portfolio against volatility. These companies will allow you to hedge against losses due to their excellent cost efficiencies.

Even when the market witnesses a downturn, they will help you mitigate the losses due to their resilience. And historically, they are known to bounce back faster when the market recovers.

8. Availability of Investment Options

Investing in blue-chip stocks is like having a buffet of options before you. You can dig in directly by purchasing the stocks, or you can take the route of ETFs (Exchange-Traded Funds) and investment funds for a more diverse spread.

It's like being presented with a menu of investment choices, whether you fancy the UK's FTSE 100, the American heavyweight S&P 500, or the dynamic Korean Exchange.

What's particularly nifty about ETFs is that they come with minimal transaction fees, which means you can diversify your investment spread without increasing costs. It's like having a smart financial sous chef helping you craft a well-balanced portfolio while keeping expenses in check.

So, whether you're a hands-on investor or prefer a more diversified approach, the world of blue-chip stocks has a little something for everyone.

9. Strong Financial Fundamentals

Blue-chip companies ride on the wings of strong financial indices. Such companies have ideal debt-equity ratios, an efficient operating cycle, and excellent financials.

Investing in blue-chip stocks instills a sense of assurance by equipping your portfolio with reduced volatility, minimized downside risk, and increased resilience in the face of unforeseen market challenges. These attributes elevate the status of blue-chip stocks above their counterparts in the broader market.

Investors with a low-risk appetite are better off investing in blue-chip stocks. You want to earn decent gain without putting all your money at risk. A blue-chip stock growth may not be exponential, but it offers more peace of mind for your investment than the regular stock.

How To Identify Blue-Chip Stocks That Are Best Fit for Your Investment Portfolio

So, you've caught the blue-chip fever, and you're convinced that they're the secret sauce for a rock-solid investment portfolio. You've probably heard that mutual funds and seasoned investors swear by them, given their heavyweight status in the financial arena and their impressive track record.

But here's the catch: not all large-cap company stocks are blue-chip. Size alone doesn't guarantee the blue-chip badge. With a wide selection of blue-chip stocks, you might wonder, “How do I pick the one that suits my investment goals best?”

That's where the fun part begins – it's like embarking on a stock market treasure hunt, searching for the perfect gem to add to your portfolio. So, let's dive into the exciting world of blue-chip stock selection and ensure your investment needs find their perfect match.

Size

Its value indicates a company's size in the stock market- or market capitalization. Market capitalization is the value of a publicly traded company's outstanding shares. It is the value you get by multiplying the total number of shares by the current market price.

Blue Chip stocks are typically huge, with a market capitalization of $10 billion or more, although stocks with a smaller market cap (still, however, generally in the billions) can be included. They also have large and steady revenue streams.

To select the best blue-chip stock, consider large-cap companies that dominate their industries. With your investment preferences and the ideal composition of your portfolio in mind, first, identify the sectors you'd like to invest in and determine the best company stocks based on their market capitalization.

Company Revenue

When you have identified the biggest companies based on capitalization in your preferred sector, the next step is to check out their revenue or income.

Ideally, the companies you would want to invest in will have a larger market share in the sector they operate in and hence, higher revenues. Compare the revenues of the biggest companies in that sector and invest in the ones with the largest.

Compare the Piotroski Score (F-Score)

A company's financial strength is a vital criterion for considering its stocks as blue-chip. The go-to tool for determining a company's financial strength is the Piotroski Score or f-score.

Created by accounting Professor Joseph Piotroski, the Piotroski Score combines 9 criteria to evaluate a firm's financial strength. These criteria include liquidity, profitability, operating efficiency, leverage, and source of funds.

A business with a high Piotroski score – 8 to 9 is financially strong and desirable from his analysis. A company with a score lower than 6 is considered to be in relatively good shape financially. Companies with scores lower than 3 are economically weak and should be avoided.

Return on Equity (ROE)

Return on Equity or ROE helps you identify companies with higher profitability as against shareholders' equity. It is a financial ratio that measures how well a company uses shareholders' funds to generate profit. A company with higher ROE means that they are more efficient when compared to their peers in the industry.

It helps to remember that each industry or sector has its own acceptable ROE. While a high ROE is a good indicator of an ideal blue-chip stock, ensure you get ROE data from the past 5 years at least. A good ROE over that period means a solid blue-stock pick.

Return on Assets (ROA)

In the same way, Return on Equity measures how efficiently a company uses shareholders' funds. Return on Assets or ROA identifies a company that uses its assets effectively to generate profit. It is the profitability of a business against its total assets less its debts.

The ability of a company to optimally utilize its resources while maintaining profitability is a good sign. It shows that the company is in capable hands and can survive any economic turbulence. This is the kind of blue-chip stock you'll want in your portfolio.

Valuation of the Company (Intrinsic Value of a Stock)

A company's valuation or intrinsic value is not the same as its market capitalization. The market capitalization is based on the price you pay for the stock. It's utterly different from the value of the company. Factors like demand and supply, and social and political environment affect a company's price, amongst other economic factors.

Therefore, it would be counterproductive to judge a company based solely on its market capitalization. The true worth of a company is its market value.

When you buy an underpriced stock, you stand to profit on your investment since you are buying it at a price less than its actual value.

So when looking for blue-chip stocks to buy, pay close attention to the stock's intrinsic value rather than the current market price. Get a list of the top companies in the industries you wish to invest in and compare their inherent value to get a short list of blue-chip stocks you want to buy.

The Bottom Line

Blue-chip stocks are a must-have in any investment portfolio for all the above reasons. With solid balance sheets, a trusted business model, steady cash flows, and a history of increasing dividends, blue-chip stocks are some of the most secure stocks you can ever buy. Due to their historically strong performance and excellent track records, seasoned investors consider them a safe haven.

Despite their much-touted safety and stability, it's best to do your due diligence before buying any blue-chip stock. Do not just invest in a company because someone recommended them. No matter how solid the investment looks, take their suggestion and do your own research before committing your hard-earned cash.