The definition of a blue chip stock
The exact criteria used to classify a company’s stock as a blue chip is relatively subjective. The title rests upon numerous ambiguities (perhaps Supreme Court Justice Potter Stewart’s famous definition applies to blue chip stocks as well as obscenity, “I can’t explain it but I know it when I see it”). Most professional investors agree that blue chips share several important characteristics including:
- An established record of stable earning power over several decades
- An equally long record of uninterrupted dividend payments to common stock holders
- A history of regular increases in the dividends payable to each share
- Strong balance sheets with a moderate debt burden
- High credit ratings in the bond and commercial paper markets
- Large size relative to American businesses as a whole in terms of revenue and market capitalization
- Diversified product lines (e.g., General Electric) and / or geographic location (e.g., Coca-Cola).
- A competitive advantage in the market place due to cost efficiencies, franchise value or distribution control
The Dow Jones Industrial Average
These characteristics usually help blue chip companies maintain their leading industry positions. The moderate debt levels and excellent credit ratings allow them to borrow money at a lower cost than their competitors. Excellent market place reputation also results in higher sales; a consumer is more likely to purchase a brand with which he is familiar despite a slightly higher price tag.
Perhaps the most famous list of blue chip companies in the world is the Dow Jones Industrial Average. This collection of thirty stocks is selected by the editors of the Wall Street Journal. The only requirement for inclusion in the index is industrial leadership. Despite this seemingly low-hurdle, each potential Dow component undergoes incredibly scrutiny, resulting in a list that stands as the most prestigious roster of blue chips in the world. The individual companies that make up the index are rarely changed; considering the inherent stability of blue chip stocks, this should come as little surprise.
Investing in blue chip stocks
There are several ways to invest in blue chip stocks. An investor can acquire shares directly through a broker, a direct stock purchase plan or a dividend reinvestment plan. He can also purchase a mutual fund that specializes in blue chip stocks. Perhaps the most effective way for the average investor to invest is to begin a dollar cost averaging plan into diamonds. Diamonds are an investment instrument traded on the American Stock Exchange; buy purchasing one share of a diamond, an investor is indirectly purchasing a fraction of each of the thirty components in the Dow Jones Industrial Average. Diamonds are preferable over blue chip mutual funds because of their low expense ratio as well as tax efficiency; because they are traded on an exchange, the underlying shares are only sold to reflect a change in the companies making up the Dow, resulting in lower capital gains taxes.
