There is no precise definition of a ‘blue chip’ stock. The term is generally used to refer to a stock that is superior to others in terms of performance, dividends and returns. They are stocks of a well established company that has a record of stable earning power over several decades, and an equally long and transparent record of payment of dividends to the stock holders.
These stocks get their name from a special chip used in gambling which is blue in colour and has the highest value. The various characteristics of this stock are that it is well proven and has an excellent track record through both good and bad times. It should also have a high credit rating in the bond and commercial paper markets and a large size relative to the stock market as a whole in terms of revenues and market capitalization.
The ‘blue chip’ status given to a company is a dynamic phenomenon and not a well established classification. This is a large cap stock that is considered a safe bet in the long run. This is because they habitually pay good dividends and are easy to liquidize in an emergency since they have an extensive and diverse product line and a global presence. As you can see, they are at the opposite end of the scale to the low priced and volatile penny stocks.
There are several ways in which blue chip stocks differ from mid cap and small cap stocks. Any small cap stock is going to be volatile, but this does not apply to blue chip stocks. In fact volatility is relatively unheard of in blue chip stocks because they are large cap stocks. This is a term coined by the investment community and it refers to a company with a market capitalization value of more than ten billion US dollars. Market capitalization is calculated by multiplying the number of a company’s outstanding shares by the stock price per share.
You can purchase blue chip stocks in several different ways. You can buy them directly from a reputed broker or via a mutual fund that specializes in these stocks. In addition, diamonds are an investment instrument traded on the American Stock Exchange. Diamonds are preferable over blue chip mutual funds because of their low expense ratio as well as their tax efficiency. Because they are traded on an exchange, the underlying shares are only sold to reflect a change in the companies making up the Dow. This results in lower capital gains taxes.