Close-up: Blue Chip Stocks

Physician's Money Digest, February 2006, Volume 13, Issue 2

n.

Blue Chip Stocks: Stocks of seasoned companies that have paid regulardividends in both good and bad years.

When an investor contemplates the term "bluechip stocks," upscale investing, positive results,and above all, wealth come to mind. That's probablybecause blue chips, like the blue chips used in pokerand other card games, are the most expensive chips.Although blue chip stocks are not always the most expensivestocks to own, they do tend to be the stocks of largercompanies that reign supreme in conservative stock portfoliosor the portfolios of retirees, nonprofit foundations,and risk-averse individuals.

The reason for the high regard placed on these stocks isthat blue chip stocks tend to be the most valuable. Many ofthem are household names, including AT&T, McDonald's,and Starbucks, and tend to be either large or mid capstocks. Bigger, of course, is not always better, and justbecause a stock is classified as a blue chip doesn't guaranteeits performance. According to InvestSmart.com,some, like Eastman Kodak, have performed quite poorlyover the past few years.

What's in a Name?

When investors consider company stocks, they tend toequate familiarity and size with safety and solid investmentreturns. However, Jim Jubak, writing on MSN MoneyCentral (www.moneycentral.msn.com), points out thatmany so-called blue chip stocks are anything but reliablewhen it comes to recent performance. Jubak points outthat some blue chip stocks have not lived up to theirname. For any stock, growth is very difficult to produce ona consistent basis. Even titans like GE, which is the embodimentof a blue chip stock for many investors, has shownfalling returns on assets since the end of 1999. HomeDepot is another example of a blue chip stock that wasonce considered a star, but has recently had difficulties infinding a strategy to perpetuate growth. Home Depotshares, as a result, have gone down 44% in the same timeperiod that GE has struggled.

Despite these ups and downs, the overarching investingprinciple behind blue chips is that most have a long operatinghistory, a good reputation, and are simply too big to fail.As such, investors reason that they must be solid investmentsthat will outperform the average stock. But Jubakpoints out that because these stocks are so familiar, they'reunlikely to dominate mature markets, and they carry hugemarket capitalizations that make outperformance unlikely.

Stacking a Blue Chip's Criteria

Investments in blue chip stocks are relatively conservativeand, of course, there's nothing wrong with a conservativeinvesting style. The following are several importantcharacteristics that most professional investors agree bluechips share:

  • An established record of stable earning power overseveral decades
  • A long record of uninterrupted dividend payments toholders of common stock
  • A history of regular increases in the dividendspayable to each share
  • Strong balance sheets with a moderate debt burden
  • High credit ratings in the bond and commercialpaper markets
  • Large size relative to American businesses as awhole in terms of revenue and market capitalization
  • Diversified product lines and/or geographic location
  • A competitive advantage in the marketplace due tocost efficiencies, franchise value, or distribution control
  • A solid reputation for quality management, products,and services

If you're considering investing in blue chip stocks, thereare several ways to do so. Physician-investors can acquireshares directly through a broker, a direct stock purchaseplan, or a dividend reinvestment plan. There are alsomutual funds that specialize in blue chip stocks.

For a list of some of the more popular blue chip stocks,check out the 30 company stocks that comprise the DowJones Industrial Average. The names on this list rarelychange.

Stealth Blue Chips

What are stealth blue chips? Think of the up-and-coming young athlete who has so far beenflying below the radar of many major leaguescouts or who plays in a small market city so he'snot well known.

Soon, his name will be known, as will thestocks in the Stealth Blue Chips portfolio, writesJim Jubak on MSN Money Central (www.moneycentral.msn.com). He points out that the averagegain for the stocks in his Stealth portfolio throughthe first quarter of 2005 was 25.4% compared to11.6% for the S&P 500 since October 14, 2003.

What are the key criteria for acceptance in theStealth Blue Chips portfolio? A market capitalizationgreater than $228 million but less than $10billion; annualized earnings per share growthabove 10% on average for the past 3 years; annualizedearnings per share growth above 10% onaverage for the past 3 years; and annual returnsfrom the stock in the top half of all stocks for eachyear going back to 1998.

Stocks that made the 2005 portfolio are Applebee'sInternational, Chico's FAS, Donaldson Co, ExpeditorsInternational, Penn National Gaming, SCPPool, Headwaters, L-3 Communications, PattersonCompanies, and Strayer Education.

POP QUIZ

1) Blue chip stocks are always the most expensive toown. True or False?

  1. True
  2. False

2) Blue chip stock investing tends to be more

  1. conservative
  2. aggressive
  3. balanced
  4. all of the above

3) A blue chip stock should have an established recordof stable earning power over several

  1. weeks
  2. months
  3. years
  4. decades

4) How many blue chip stocks comprise the Dow JonesIndustrial Average?

  1. 10
  2. 20
  3. 30
  4. 40

5) A criterion for inclusion in Jim Jubak's Stealth portfoliois market capitalization less than

  1. $5 billion
  2. $10 billion
  3. $15 billion
  4. $20 billion

Answers: 1) b; 2) a; 3) d; 4) c; 5) b.