What To Consider Before Investing in Blue-Chip Shares

If you’re looking to buy blue-chip shares, learn about all the key considerations you have to keep in mind before investing

5 Min Read
Last Updated July 21st 2021

It is no secret that many investors prefer blue-chip stocks because of their stable earnings. During an economic downturn, investors generally turn to these perceived "safe haven" shares because of their steady nature. So as an investor, what to consider before investing in blue-chip stocks? 

Before we jump into the details, let us understand what blue-chip stocks are, the advantages they offer, and the factors to consider before investing in these companies/funds.

Blue-chip stocks refer to shares of massive, established and financially steady firms that have been around for a long time. The term comes from poker, where a blue chip holds the highest value. On Wall Street, a blue-chip stock is usually a highly valued and renowned company with attributes that benefit investors in the long run. These include stable cash flows and consistent dividends. Many people believe that blue-chip companies offer security during times of slow growth due to their experienced executive teams and their ability to generate constant profits.

These stocks are known for their capacity to endure adverse market conditions and generate high returns in favourable market conditions. Typically, companies with blue-chip stocks are not only premium but also dominant in their sector. Experts consider these firms to be among the best organizations in their respective industries.

Why Choose Blue-Chip Stocks? 

Blue-chip stocks are stocks of well-established companies. Most of these yield stable returns for investors. Because of this consistency and security, investors are largely protected from inflation, market recessions, and economic uncertainties. In addition, these companies record consistent annual returns across extended periods with a stable debt-to-equity ratio.

The average return on equity (ROE), Price-to-Earnings ratio (PE), and the interest coverage ratio of blue-chip firms show a steady performance. Moreover, as these companies offer regular dividends to their shareholders, it helps them make a regular income. In other words, buying blue-chip stocks is a worthy investment due to these firms' strong financial position, a great balance sheet, a stable growth rate, and the best managerial team.

Dividends on Blue Chip Stocks

As blue-chip shares are typically sophisticated companies that have realized large market caps, most pay dividends. Dividends are a portion of a company's profits distributed to shareholders in the form of quarterly payments. Smaller companies growing fast generally retain all of their earnings to invest in future growth. 

These growth stocks may eventually pay dividends once they are of adequate size. Until then, a fast-growing or young company is not likely to pay any dividends. On the other hand, blue-chip stocks have seen increased and constant dividends over time. 

In the long run, the benefit to the shareholder from the dividend payments is portfolio income, regardless of the swings in the share price. In addition, dividend payments can also help protect against the harsh effects of inflation as dividends represent earnings, which increases along with the general cost of living.

Check Out: 5 of the Best UK Dividend Stocks to Buy

Factors To Consider Before Investing in Blue-Chip Shares 

Evaluate these factors before buying blue-chip stocks. 

1. Investment objective 

This is the first aspect that one must examine before considering investments, not just in blue-chip stocks but in any investment scheme. Is your investment goal short-term, medium-term, or long-term? Remember that the investment market is swamped with plenty of options. Hence, you should choose a fund whose business strategy can help you meet your investment objective. Investors with some risk appetite and a long-term investment horizon can consider buying blue-chip stocks.

2. Exit load

Exit load refers to the fee charged by an asset management company from the investor during the withdrawal or redemption of the fund units. If a blue-chip fund has a higher exit load, it might be a disadvantage to the investor, especially if they redeem the stocks shortly after the investment. However, if investors plan to retain their units for the long run, they do not have to worry about the exit load. 

3. Risk appetite

Remember that blue-chip funds predominantly invest in equity and equity-related instruments. Investments made in equity schemes are subject to market volatility. Hence risk-averse investors who wish to keep their finances away from volatile market conditions must reconsider investing in equity-related instruments like blue-chip funds.

Significant Advantages of Investing In Blue-Chip Stocks

 Portfolio diversification

Blue-chip companies are high-profile business organizations that do not generate revenue from just one channel. Buying blue-chip stocks allows investors to cushion their losses against operational setbacks and spread out the associated risks.

 Liquidity

Blue-chip companies enjoy market goodwill and high creditworthiness. Therefore, it directly enhances the market value of blue-chip stocks and makes them an attractive investment option for investors. This directly facilitates the purchase and sale of such stocks, making them liquid in nature.

 Stable and regular dividends

Irrespective of the market conditions, blue-chip stock investors generate stable returns. Such returns are generated in the form of dividends, which are extended to investors quarterly.

Don't Miss: Benefits of a Long Term Investing Outlook

Who Should Invest In Blue-Chip Stocks?

Blue-chip stocks are ideal for investors looking to realize the benefits of getting high returns on capital and generating regular periodic income. These stocks make for excellent retirement savings as they are highly valued, excellent long-term investment options. The uninterrupted dividend payments make for steady portfolio income over time.  

These stocks may not be best suited for the smaller investor because of the higher price per share, increased focus on dividend payments, and higher downside risk. Therefore, it is essential to be aware of your risk tolerance and financial profile before making any investments. 

In Conclusion

Before buying blue-chip stocks, you should consult an investment advisor, in addition to performing your research on the best-performing companies. Evaluate the recent annual and quarterly published reports of stocks to understand their performance. Regarding what to consider before investing in blue-chip stocks, the above-listed pointers will help you make safer, well-informed decisions.

You must also analyze the company’s performance for the last decade to know the dividend payments trend and the reported earnings. Looking at the historical performance over a long period will give a more precise indication of a company’s performance during both boom and bust cycles. Finally, compare several high-quality stocks and decide which ones to invest in based on your stock evaluations and personal investment goals. 

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