Lesson 25 of 43 (Blue Chip Investing): A Step-by-Step Guide to Picking the Best Blue Chip Stocks

  • Blue chip stocks get their name from the blue poker chip, which holds the highest value.
  • Blue chip stocks are generally large, well-known, high-quality industry leaders with reliable financial performance and growth.
  • In general, blue chips are considered a “safer” investment with less volatility and less vulnerability during a market downturn (their steady dividends help with this).
  • We walk through a step-by-step guide to finding the best blue chip stocks, including screenshots and direct links to a stock screener that’s pre-filtered for high-potential blue chip stocks.

IIn our last lesson we walked through how to find the best large cap stocks. Now we’re going to focus on an even smaller subset of the large cap pond: blue chip stocks. 

Today we’re going to cover four important questions about finding the best blue chip stocks:

  1. What are blue chip stocks?
  2. What should you know about investing in blue chip stocks?
  3. Which blue chip stocks perform best?
  4. How do you find the best blue chip stocks to buy? (A step-by-step guide)

What Are Blue Chip Stocks?

Blue chip stocks get their name from the blue poker chip, which holds the highest value.

While there’s no strict definition of what makes a company a blue chip stock, they’re generally large, well-known, high-quality industry leaders with reliable financial performance and growth.

When people discuss “blue chip stocks,” they’re usually referring to household brand names with a long history of steady performance and a dominant market share in their industry.

What Should You Know About Investing in Blue Chip Stocks?

Blue chip stocks often have stable revenue and earnings growth driven by a proven line of mature products. For example, Walmart (WMT) is one of the largest physical and online retailers in the world with over 5,000 stores in the U.S.

In general, blue chips are considered a “safer” investment with less volatility and less vulnerability during a market downturn (their steady dividends help with this).

However, the flip side is that their growth is often much slower than up-and-coming small cap stocks or mid cap stocks. In fact, sometimes their growth is actually in decline. For example, IBM (IBM), Coca-Cola (KO), and McDonald’s (MCD) – classic blue chip stocks – have all seen years of declining sales.

To make up for slower growth, blue chip stocks often pay steady dividends. Since they’re already large cap companies that have a range of mature products, they decide to return a sizable portion of their earnings back to shareholders by paying dividends.

If you want to buy blue chips for your portfolio, start by looking at the Dow Jones Industrial Average (DJIA) which holds 30 blue chip companies like Apple (AAPL), Nike (NKE), Verizon (VZ), Walgreens (WBA), Merck (MRK), Caterpillar (CAT), Disney (DIS), and Walmart (WMT).

In addition, the S&P 500 holds many high-performing blue chips stocks.

But keep in mind, blue chip stocks are a bit of a double-edged sword.

On the one hand, they’re among the largest, most stable, most predictable companies available on the market.

On the other hand, there aren’t many of them and they’re extremely well researched and covered by analysts and investors. This means your number of choices are very limited and blue chips are much less likely to be dramatically undervalued or overlooked by Wall Street.

For example, out of nearly 9,000 stocks traded in the U.S., there are probably less than 100 blue chip stocks. So by focusing on blue chips, you’re instantly reducing the stocks you’re considering by nearly 99%.

Now, some would argue that the remaining 1% is the cream of the crop.

And others would argue (including us) that you can find the same things you like about blue chip stocks (steady performance, healthy dividends, low volatility, economically defensive) in many other companies that aren’t considered blue chip stocks.

It’s up to you to decide which strategy is best for you. Let’s walk through which blue chip stocks perform best and how to find them.

Which Blue Chip Stocks Perform Best?

When it comes to buying blue chips, you’re working with a very small pool of stocks.

As mentioned above, some people would consider the Dow Jones index to be blue chips stocks, and there are only 30 companies on that list!

For our purposes, we’ll expand that a bit to include all companies in the S&P 500.

When looking through the S&P 500 for the best blue chips, we’ll focus on finding stocks that meet these criteria:

  1. Profitable and growing financial performance
  2. Modestly undervalued (definitely not overvalued)
  3. Low volatility (a stable and steady stock)

Put simply, we’re looking for large, well-known, growing companies that are stable and modestly undervalued.

Let’s see how we can break that down into a FinViz stock screen.

How Do You Find the Best Blue Chip Stocks to Buy? (A Step-By-Step Guide)

In order to find a short list of the best blue chip stocks for your close research, we designed the following screen.

As always, the yellow coloring indicates the metrics we’ve selected for our screen:

To see the full screener in FinViz and adjust it for yourself, click here.

When we applied the criteria below, it shrunk the 500 stocks in the S&P 500 down to just 40 companies!

We’d consider all of the remaining 40 to be high quality candidates worthy of your close research.

The results included companies such as Allstate (ALL), Best Buy (BBY), Quest Diagnostics (DGX), Costco (COST), Intel (INTC), Progressive (PGR), and Verizon (VZ).

These were just the results at the time we ran the screen. Please be sure to recheck the link above to see what makes the cut today.

Let’s review how we arrived at this screen. As usual, we’ve left the criteria a bit loose so you can tighten wherever is best for you.

In order to find companies with profitable and growing financial performance, we applied a few critical metrics:

  • EPS growth past 5 years = positive
  • EPS growth next 5 years = positive
  • EPS growth this year = positive
  • EPS growth next year = positive
  • Sales growth qtr over qtr = positive
  • Sales growth last 5 years = positive
  • Net profit margin = positive

And to screen out companies that are overvalued, we applied these powerful valuation metrics:

  • P/E is under 30
  • Forward P/E is under 30
  • Price / Free Cash Flow is under 50
  • Price / Sales is under 5

Finally, in order to find steady and stable stocks we screened for companies with a beta of less than 1.0.

As a reminder, beta is a measure of how much a stock moves relative to its benchmark. A beta of less than 1.0 indicates a stock is more stable than the market and a beta of greater than 1.0 shows the stock tends to swing more than the overall market.

By applying growth / profitability metrics, checking valuation, and focusing on low beta stocks, you should be left with a short list of high potential stocks for further research. 

Lesson Summary (Blue Chip Investing): A Step-by-Step Guide to Picking the Best Blue Chip Stocks

When it comes to investing in blue chip stocks, you have a short list of large, well-known companies to pick from.

In this lesson, we outlined some key strategies to find the best blue chips stocks, and covered the following key takeaways:

  1. Blue chip stocks get their name from the blue poker chip, which holds the highest value.
  2. Blue chip stocks are generally large, well-known, high-quality industry leaders with reliable financial performance and growth.
  3. When people discuss “blue chip stocks,” they’re usually referring to household brand names with a long history of steady performance and a dominant market share in their industry.
  4. In general, blue chips are considered a “safer” investment with less volatility and less vulnerability during a market downturn (their steady dividends help with this).
  5. To make up for slower growth, blue chip stocks often pay steady dividends. Since they’re already large cap companies that have a range of mature products, they decide to return a sizable portion of their earnings back to shareholders by paying dividends.
  6. There aren’t many blue chips on the market and they’re extremely well researched and covered by analysts and investors.
  7. Out of nearly 9,000 stocks traded in the U.S., there are probably less than 100 blue chip stocks. So by focusing on blue chips, you’re instantly reducing the stocks you’re considering by nearly 99%.
  8. We believe you can find the same things you like about blue chip stocks (steady performance, healthy dividends, low volatility, economically defensive) in many other companies that aren’t considered blue chip stocks.
  9. To find the best blue chip stocks, look for large, well-known, growing companies that are part of the Dow Jones or S&P 500, stable, and modestly undervalued.
  10. You can access the blue chip stock screen here


Data as of 10/10/18

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Author

Todd Lincoln

Author

Passionate stock market investor with deep experience trading small cap, dividend, and growth stocks.

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