Legend has it that the term "blue chip" stems from poker, in that it represented the poker chip with the highest value in the game. These days, the term is ubiquitous in the stock market and refers to a large, stable company that is financially sound, has well-known brand and market awareness and a diversified sales base.
Blue chips are also frequently known as industry bellwethers. A perusal of the 30 companies that make up the Dow Jones Industrial Average is perhaps the best illustration of blue chips across a wide array of industries. Prime examples include Coca Cola (NYSE: KO), American Express (NYSE: AXP) and Intel (Nasdaq: INTC), as they dominate their respective industries and their corporate logo qualifies as a global brand with billions of dollars in brand equity.
Interestingly, these companies have been laggards in terms of overall stock market returns. This is in stark contrast to historical periods when they have been the most sought after firms for investors. The Nifty 50 stocks in the 1960s and 1970s represented a time when investing in the largest firms in the market was seen as a no-brainer -- these stocks could be held forever because it was difficult to see them lose competitiveness to smaller, lesser capitalized rivals.
The late 1990s represented another period where investors held blue chips in high regard and bid valuations to more than 50 times earnings in many cases. These days though, blue chips are trading at low double-digit multiples of their earnings, as it has taken a decade for sales and profit growth to catch up to the lofty valuations placed on these firms during what is now considered the dot-com bubble.
At some point, perhaps in the very near future, investors will again reward quality companies with higher valuations. In addition, these firms are large and globally diversified, which means they should be able to withstand downturns in the business cycle and expand in faster-growing emerging markets. As such, blue-chip investing has great appeal right now.
Downside protection is another strength these firms offer investors. A large number of investors remain worried about global economic growth, given that we just went through one of the worst financial crises since the Great. For the most part, blue chips, barring a select class of unfortunate financial titans, have survived the global meltdown with flying colors.
Given the valid concerns regarding a double-dip or prolonged recession in the global economy, Wal-Mart (NYSE: WMT) is the blue chip that every investor should own. It has survived two major recessions in the past decade, demonstrating it is capable of withstanding "tail risk" (a supposedly improbable market meltdown that is occurring with regularity in the market) and was one of only a few firms that actually benefitted during a recession.
The stock hasn't done much during the past decade. This is because the price-to-earnings (P/E) ratio was at 47 back in 2000. Sales and earnings have grown about +10% annually during this time frame though, and though double-digit sales growth will be challenging in the next decade, management has the discipline and wherewithal to high single digit top-line growth into +10% or higher profit growth well into the future. And Sales upside does still exist as Wal-Mart expands globally. As a case in point, it has seen success in cost-conscious markets such as Mexico and just announced ambitious expansion plans into Africa.
Action to Take ---> At a current P/E of about 14, this means that shareholders can expect investment returns along these levels. Throw in potential earnings multiple expansion (though 47 seems like a huge stretch) and a 2.3% current dividend yield, and it's hard to see a safer investment out there that also offers a high likelihood of solid returns for many years to come.