Blue chip companies with a history of paying dividends will be among your most profitable stocks

Blue chip companies are typically defined as firms whose stocks have a national reputation for quality, reliability and the ability to operate profitably in good times and bad.

You can look at blue chips as the strongest, most secure, and most profitable stocks on the market. Just be sure you look at the stock’s qualities and not just at the label.

True Blue Chips pay off Learn everything you need to know in 'The Best Blue Chips for Canadian Investors' for FREE from The Successful Investor. Canadian Blue Chip Stocks: Bank of Nova Scotia Stock, CP Rail Stock, CAE Inc. Stock and more.  I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

How the most profitable stocks in blue chip companies can benefit your portfolio

We advise investors to look for blue chip companies that are likely to pay off if business and the stock market are good, but that won’t hurt them too much during those inevitable periods when business or the markets are bad.

If you follow our three-pronged approach—diversifying across most if not all of the five main economic sectors, avoiding stocks in the broker/media limelight, and sticking mainly to well-established companies—then you can be almost certain of long-term gains in excess of what you’d get with any other investment approach.

If a deep or long-lasting market setback does occur, any aggressive stocks you own are likely to fall more than shares of blue chip companies. The eventual recovery of aggressive stocks is also less certain. That’s why we recommend that you hold the bulk of your investment portfolios in securities from blue chip companies.

If your stocks offer good “value”—if they trade at reasonable multiples of earnings, cash flow, book value and so on—then your risk is lower. However, standards change. Many attractive stocks now trade at 15 to 25 or more times earnings. If their earnings drop due to business conditions, and if the market p/e falls to, say, 10 to 15 times earnings, then even stocks of blue chip companies are going to suffer.

The most profitable stocks and their relationship to dividends

For a true measure of stability, focus on companies that have maintained or raised their dividends during economic and stock market downturns. These firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they provide an attractive mix of safety, income and growth.

You should also keep these two key points in mind:

• Dividends can grow. Stock prices rise and fall. That means capital losses often follow capital gains, at least temporarily. Interest on a bond or GIC holds steady, at best. But the best dividend stocks like to ratchet their dividends upward—hold them steady in a bad year, and raise them in a good one. That gives you a hedge against inflation.
• Dividends are a sign of investment quality. Some good companies reinvest profit instead of paying dividends. But fraudulent and failing companies hardly ever pay dividends. So if you only buy stocks that pay dividends, you’ll automatically stay out of almost all the market’s worst stocks.

These type of blue chips will probably not become some of the most profitable stocks

It’s crucial to downplay stocks—even blue chip stocks—that seem to be near-universally recommended by brokers and are often the subject of favourable media coverage. That’s because, in investing, familiarity can breed excessive feelings of comfort, security and performance.

After all, brokers get information from the media, investment journalists spend a lot of time talking to brokers, and company managers listen to both. A feedback loop can develop that spurs high expectations, derails criticism, and leads companies (and their investors) to make devastating mistakes. You may get the feeling these are can’t-miss investments and that it’s safe to buy and forget them. That’s exactly the wrong thing to do with them. In fact, your in-the-limelight stocks are the ones you most need to watch closely.

Instead of familiarity, aim for investment quality and diversification in your investment decisions. At any given time, lots of prosperous, well-established companies—the best blue chip stocks included—are out of investor fashion. Some of the biggest profits you ever make will come from buying these stocks before they find their way into the limelight.

What blue chip stock has served you well? Which one has not?