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Blue Chips: Not the Kind You Eat

In the world of investing Blue Chips are known as large, financially established companies with generally attractive stock prospects. Think of iconic American brands like Disney, Walmart, General Electric, Intel, or Visa. In fact, all thirty of the constituents of the Dow Jones Industrial Average can be considered good examples of Blue Chips.

Given the financial well-being of Blue Chip companies, they often pay a tasty dividend that can be just as pleasing to your portfolio as those corn tortilla Blue Chips are to your palette. All joking aside, since Blue Chips are well-established financially they generate excess cash that can be returned to shareholders in the form of a dividend. In some cases, the dividend payment and persistent growth in payouts is the best reason for owning one of these stocks. Furthermore, dividend-rich companies can be used as an alternative to comparable fixed income products in a low interest rate environment.



In addition to the stream of dividend income, Blue Chips offer some price appreciation potential. However, since these are some of the largest publicly traded companies in the world you should not expect for any of these stocks to routinely double in value. Instead as a shareholder in one of these companies you can accumulate wealth by reinvesting your dividends. For example, if you own a stock and it pays a dividend you can opt to use the payment to repurchase more shares, thereby increasing your ownership stake and compounding your earnings over time*. Most companies offer a Dividend Reinvestment Plan or DRIP for short, which automatically reinvests your dividends each payment cycle.

As the stock price ebbs and flows, your dividends will purchase a proportionately greater or lesser amount shares as the market declines or rises, respectively. For most investors the best time to accumulate a large stake in an iconic brand is during a period in which the general market conditions have pushed the stock price down, the price over-reacts and declines on bad news from the company, or there are some transitions underway in the company’s management team. Moreover, Warren Buffett advises that you “Look at the market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”

Given the diversity of revenue sources for a large multi-national company and their ability to better withstand market declines, it can behoove investors to think more strategically when buying and selling Blue Chips. In other words, think of investing in Blue Chips stocks just as you would invest in your 401K** plan. Contributing more money to a particular asset class, or Blue Chip, that has declined in value can offer a good opportunity to purchase more shares that will show an even greater profit once the stock price recovers due to your increased ownership stake.

Of course, you should not just blindly buy because the stock is down in value. Take a moment to determine if there is a structural problem with the company, if the price is being weighed down by the market, or if the company is experiencing some temporary problem. Investing requires diligent effort on a consistent basis so be sure to have a plan before starting. Over time, say every three to five years***, you can assess how your strategy is performing.

Overall, Blue Chips are a great wealth-building tool for investors. They offer the individual investor an ownership stake in a quality company and a regular income stream in the form of dividends. Combine reinvested dividends with the potential for future price appreciation and you are putting the odds in your favor for accumulating wealth.

As always, if you have questions or comments, feel free to send me a message. Thanks for reading.

JD


*See my post on “Daymond John’s Money Tips” here to get a better understanding of the power of compounding.

**Please reference my post “The Benefits of Participating in Your Company’s 401K Program“ here for more information on 401K Plans.


***Three to five years is the expected timeframe for a full market cycle. That is, it usually takes this long for a stock market or economy to move out of a recession into an expansion and back into a contraction. For more information on recessions and economic cycles see my post here entitled “What is a Recession?”
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