Investors looking to build a portfolio of stocks or supplement their portfolio of index funds with individual stocks (known as “core-and-explore”) would be wise to stick with the largest, most well-known companies in North America. Known as blue-chip stocks, these companies tend to be leaders in their respective industries and offer indispensable products or services.
Blue-chip stocks have a number of characteristics that appeal to investors.
- They tend to be large and highly profitable businesses (industry leaders)
- They often pay (though not always)
- They’ve been in business for a long time (often 100 years or longer)
- They sell products or services that everyone has heard of (and consumers can’t live without)
- They tend to have the highest trading volume (popular stocks to buy and sell)
- Their stock performance tends to be safe, reliable, and predictable (often beating the broader market)
The term blue-chip stock comes from poker, where blue chips have the highest value. On a stock exchange, the term blue-chip can be subjective (there is no definitive measurement); however, the companies with the highest market capitalization or value tend to be referred to as blue-chip stocks.
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The bottom line: Should I invest in blue chip stocks?
Picking individual stocks is generally not recommended as a long-term investment strategy. There’s an overwhelming amount of academic and empirical evidence that shows why active management (stock picking and market timing) underperforms passive management (investing in low-cost index funds).
Still, if you have a stock-picking itch to scratch, you could do worse than selecting a diversified basket of blue-chip stocks. Companies with these characteristics (large, profitable, dividend-paying, low book-to-market) can deliver strong returns and even outperform the broader market for long periods of time.
Canadian investors can “skim” the top blue-chip companies to form the Canadian equity component of their portfolio and avoid paying any ongoing management fees. This approach is generally paired with investing in index funds for U.S. and international stock exposure.
If you are investing in blue-chip stocks make sure to use a discount brokerage platform where you can trade stocks for free (Wealthsimple Trade) or for a minimal cost (Questrade).
Finally, don’t just blindly follow a list of names you know (remember Kodak?). Instead, do your own research to screen for and identify blue-chip stocks that meet your criteria. Don’t stray from it and go chasing stocks with unsustainable dividend yields, or small stocks that don’t meet your “blue-chip” definition.
A portfolio made up of strong, profitable, blue-chip companies is a portfolio built to last.