What’s a blue chip?What’s a blue chip?

There are all kinds of blue chip companies in Australia and the USA (and on Sharesies!), so it’s useful to know how to identify them, why people invest in blue chip companies, and some of the potential tradeoffs when investing in blue chip companies.

Identifying a blue chip

Blue chip companies share a few characteristics:

• They tend to be among the top performers in their industry. This means you’ll recognise lots of them.

• They tend to be older companies. You don’t become a blue chip company overnight. Rather, blue chip companies have had many years to develop their business and build a strong reputation.

• They tend to have large market capitalisations—the total value of all their shares.

• They tend to pay regular dividends.

You can often identify blue chips on an exchange by sorting by “Market cap”. If you do this, you’ll find companies like BHP (a huge mining company) and some of the big banks (like ANZ and Commonwealth Bank of Australia). You’ll also see companies like Wesfarmers, which owns household name brands like Bunnings and Kmart. 

Why invest in blue chips?

Now that we’ve identified some blue chip companies, we can look a little wider—what are the benefits of investing in blue chip companies?

One of the main reasons some investors like blue chip companies is because they may be lower risk compared to newer, untested companies. Companies like Wesfarmers or Telstra are well-established, and this means we can see their patterns of what they have done in the past. For example, they tend to have strong track records of paying dividends to investors. Of course, this doesn't mean they will always pay a dividend, but it helps you understand how they’ve acted in the past. 

What’s more, blue chip companies can be stable in bad times, because they have years of growth and goodwill to fall back on. 

Basically, a blue chip company is like a person with lots of work experience and a big savings account; if they lose their job, they can fall back on the savings account while they find another one—which won’t be too hard, because they have a really solid reputation that takes years to build. A newer entrant is more similar to a person with no savings account, or even lots of credit card debt—if they lose their job, things can go from bad to worse really quickly.

So investing in blue chip companies is one way to seek a more stable investment. That doesn’t mean they’re a sure thing, of course—all investing is risky. But blue chip companies may be less risky than other companies.

What’s the tradeoff?

Blue chip companies are generally large and dominate the business sector they are in. There are still risks. The sector they are in may have limited growth potential. This may lead to the company not performing as well to the overall market index. Blue chips being larger, are subject to technology disruption and potentially loss of market share to new technologies or more agile companies. For example, Kodak, once valued at US$31B, was removed from the Dow Jones in 2004 after 74 years within the index due to technology disruption of cameras and film. 

No sure things

The last tradeoff with blue chips, which comes with all investing, is that there are no truly sure things in investing. It is true that blue chip companies are probably less likely to lose value, or pay smaller dividends than expected, than non blue-chip companies. But that doesn’t mean they’re risk free.

In the global financial crisis in 2008, some blue chip companies went out of business entirely, or had to be bailed out. A year later, General Motors went bankrupt and needed money from the government, and major investment bank Bear Sterns is no longer with us. So even though blue chip companies have a past history of being reliable, it’s worthwhile to think about diversification, because blue chip doesn’t mean “invincible”. 

Get started!

Blue chips are common investment choices, and there are plenty available on Sharesies. If these are of interest as an investment option, go and give them a look and see if they meet your circumstances and investment goals!