The features of blue chip stocks make for appealing investment choices. Who doesn't like investing in a large, stable company that makes a lot of money and pays a steady and growing dividend? Buying blue chip stocks and holding the shares for the long term -- reinvesting dividends along the way -- is not a bad way to build wealth. However, as a younger investor with many years ahead to participate in the market, limiting yourself to a handful of high-quality companies could also limit your stock market profits.
Moderate Growth Prospects
Because a blue chip stock is, by definition, a large, stable company, the potential for market beating growth is very slim. To a great extent these stocks are the ones that drive the market averages, so the returns from blue chips as a group will not stray far from the returns of the stock market indexes. Consider a blue chip stock like Coca Cola and a new upstart beverage company. The new, small company has the potential to increase sales and profits by 50 percent or 100 percent with a hot product. Since the whole world already drinks gallons of Coca Cola products each day, it is a near impossibility for the blue chip company to come up with something new that would double sales.
Focus on Dividends
Older investors like blue chip stocks for the steadily increasing dividend payments. These are companies that have increased the annual payout for many years, sometimes decades. The steady payout of profits as dividends is great for the investor collecting those dividends to cover retirement expenses. As a young investor, you may want to buy stocks of companies whose profits are reinvested to make the business and share price grow faster than the average for the stock market. Growth stocks -- rather than dividend stocks -- are more likely to enable you to build wealth.
As a younger investor, you have a significant advantage over older stock buyers. You very likely have an understanding and knowledge of the hot new products in sectors like technology and retail. These products are often sold by newer, hipper companies that will not be on anybody's blue chip stock list. Any money invested in an older, boring, established blue chip company is money you do not have to purchase stocks of companies that are on the cutting edge of what is happening in the economy.
Bigger Downside Risk
Blue chip stocks are heavily followed by Wall Street analysts and widely owned by the investing public. This type of stock is purchased for the stable growth history and projections that growth will continue. Any company can run into difficulty, however, and the investing public can be very unforgiving if a favorite fails to live up to sales and profit expectations. Most potential good news is already built into the stock price of a blue chip favorite. Bad news tends to be unexpected and can cause significant damage to the share price.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.