Blue chip investments are key components of successful investor portfolios

Blue chip investments are well-established companies with attractive business prospects. Well-established firms have the asset size and the financial clout—including solid balance sheets and strong earnings and cash flow—to weather market downturns or changing industry conditions.

The best blue chip investments have strong positions in healthy industries. They also have strong management that will make the right moves to remain competitive in ever-changing marketplaces. Blue chip investments should always be prominent, if not dominate firms, in their industry.

Because of this, blue chip companies can give investors an additional measure of safety in today’s volatile markets. And the best ones offer an attractive combination of moderate p/e’s (the ratio of a stock’s price to its per-share earnings), steady or rising dividend yields (annual dividend divided by the share price) and promising growth prospects.

We feel most investors should hold the bulk of their investment portfolios in blue chip investments. All these stocks should offer good “value”—that is, they should trade at reasonable multiples of earnings, cash flow, book value and so on. Ideally, they should also have above average-growth prospects, compared to alternative investments.

11 tips for picking the best blue chip investments:

1. Review the company’s finances going back 5 to 10 years. The types of blue chip investments we recommend have a history of profits going back for at least that long. Companies that make money regularly are safer than chronic or even occasional money losers.
2. Blue chips investments should pay dividends. Review a company’s 5 to 10 year record of paying dividends. Companies can fake earnings, but dividends are cash outlays. If you only buy dividend-paying value stock picks, you’ll avoid most frauds.
3. However, be wary of any blue chip stock with an unusually high dividend yield. Investors should avoid judging a company based solely on its dividend yield (the percentage you get when you divide a company’s current yearly payment by its share price). That’s because a high yield can sometimes be a danger sign rather than a bargain. For example, a dividend paying stock’s yield could be high simply because its share price has dropped sharply (because you use a company’s share price to calculate yield) in anticipation of a dividend cut.
4. Good blue chips have low debt. It doesn’t matter if you’re investing in blue chip stocks or penny stocks, the company under consideration should have manageable debt. When bad times hit, debt-heavy companies often go broke first.
5. Blue chip investments should have industry prominence if not dominance. Major companies can influence legislation, industry trends and other business factors to suit themselves.
6. The best blue chip investments have geographical diversification. Canada-wide is good, multinational better. There’s extra risk in firms confined to one geographical area.
7. Good blue chip investments have the freedom to serve (all) shareholders. High-quality stock picks must be free of excess regulation, free of dependence on a single customer, and free from self-dealing insiders or parent companies.
8. Some of your blue chip investments should have freedom from business cycles. Demand periodically dries up in “cyclical” businesses, such as resources and manufacturing. You can hold some blue chips from those sectors, but look as well for companies that have broad product lines or products that are indispensable.
9. Blue chip companies should have ownership of strong brand names and an impeccable reputation. Customers keep coming back to these businesses, and will try their new products.
10. Good blue chip investments may have hidden assets in the form of real estate. For instance, when a company buys real estate, the purchase price goes on its balance sheet as the historical value of the asset. Over a period of years or decades, the market value of that real estate may climb substantially. But the purchase price remains unchanged on the balance sheet. You have to look closely to spot this hidden value. At times, the hidden value in a company’s real estate can come to exceed the market value of its stock. This hidden value may only become apparent to investors when the company upgrades the use of the real estate. For example, a merchandiser might repurpose a parking lot to build a shopping mall with a residential condo tower on higher floors, and a parking garage down below.
11. Some blue chip companies may have a hidden asset in their relationship with a loyal customers. After a series of satisfactory dealings, long-time customers develop a level of trust that makes them receptive to related offerings from the company. For example, Apple Computer was able to move into the digital music player and smartphone businesses as quickly as it did in the past decade because it had an established core of fans for its Mac computers.

Finding good blue chip investments take a lot  of research, but their long-term payoff is well worth it. What are some of the financial or industry signals you look for in blue chip investments? Share your thoughts and experience with us.