Blue chip stocks are often characterised as boring and unappealing to young investors. But this isn’t the case as buying blue chip stocks could be the ideal strategy for investors of all shapes and sizes with a long-term goal and vision.
What Is A Blue Chip?
Most new investors are familiar with the term blue chip stocks, either through financial media outlets or overhearing family conversations. Simply put, a blue chip refers to a well-established company that typically holds a top-five market position in their respective industry.
Blue chips tend to have global operations and sell billions of pounds worth of products or services. Their market capitalisation is in the tens of billions of pounds, with some global blue chip stocks worth hundreds of billions.
These companies mostly make up a stock market index, such as the Financial Times Stock Exchange 100 Index, or the “Footsie” for short. The index includes the 100 biggest companies listed on the London Stock exchange. The three largest constituents by market capitalisation are global bank HSBC (£111.64 billion), pharma company AstraZeneca (£97.365 billion), and oil company BP (£90.9 billion).
Investors who are just starting to invest and don’t have a lot of capital may want to consider contracts for difference (CFD) platforms like Plus500 UK. A CFD platform offers clients the ability to profit from the price movement of stocks without actually owning shares. Instead, a client enters into a contract with the broker and can make a profit from future changes in prices.
All About The Strength
Investors love to invest in blue chip stocks because it is more likely to not only maintain their dominant market position but have plenty of resources and know-how to continue growing. Big companies are also flush with cash so they have no problem buying out fast-growing competitors. One example is U.K.-based Unilever’s 2016 acquisition of Dollar Shave Club for an undisclosed amount.
Companies worth many tens of billions of pounds are also in a much better position to ride out any economic hardships or slowdowns. These companies can lower prices during a recession and sacrifice near-term profit to outlast rivals who could even fold when times are tough.
Consistent Dividend Instead Of Share Price Growth
Blue chip stocks are known for rewarding investors with a consistent and in many cases generous dividends. Several stocks on the FTSE index offer a dividend yield above 7% which is around twice the FTSE 100 average just above 4%.
Investors can choose to have their dividends reinvested back in the blue chip stock if they believe it to still be cheap. As tempting as it may sound to pocket a dividend payout, the benefits of dividend reinvestments speak for themselves. Suppose an investor owns a portfolio worth £100,000 that pays a 4% annual dividend yield. If the investor reinvests each and every dividend payment, their portfolio will increase in value to £219,112 in 20 years and pay £8,427 in dividends — assuming zero change in the price of the investment and dividend payout.
When A Blue Chip Isn’t Right For You
There is no one-size-fits-all investment strategy and what is ideal for one investor may be a bad idea for another. Blue chip stocks are a perfect tool for investors with long-term financial goals and objectives, such as retirement or buying a second home.
Younger investors who just started working may find it more advantageous to take on a greater, but still reasonable degree of risk. The logic being small losses have less of an impact on young people compared to those close to retirement. For example, a 25-year old losing 20% on a £10,000 portfolio should be able to easily recover the losses. But a 55-year old that is a few years away from retirement could be devastated if their life savings lose 20%.
Perhaps more important, blue chip companies require decades to rise to global dominance. Certainly, young investors should try and find the next “big thing” and watch their small-cap investment slowly but steadily expand to become a global giant.