NEW YORK (CNN/Money) -
What do you think about the strategy of buying blue-chip stocks and then holding them for the long haul?
-- May Lu, Philadelphia, Pennsylvania
I'm all for it, with a few qualifications. First of all, the term "blue chips" is more art than science. The word actually originated not in the investing, but the gambling world around the beginning of the last century because blue was the highest denomination of the various chips used in poker.
The vestiges of blue-chips gambling legacy continued into the go-go years of the '90s, when people began applying the term blue chip to a lot of the tech and dot-com stocks that had ballooned in market value.
Unfortunately, many new blue chips (sometimes called "nouveau" blue chips) like WorldCom and Amazon wound up getting beaten black-and-blue as they plummeted from the insane peaks manic investors had bid them up to during the bull market feeding frenzy.
Definitions of "blue chip" vary
So you've got to be careful about what kind of stock actually qualifies as a blue chip. I don't have an official "Ask the Expert" definition, but before I'd consider a company a blue chip, I'd want to see at least a decade of reliable earnings growth, a strong balance sheet with little or at least an easily manageable level of debt and a management team with a proven ability to lead the company not just through economic booms but recessions as well.
But that's not all. I'd also want a company that dominates the areas in which it does business and still has opportunity to expand. In short, a true blue chip should not only have a sterling past but a solid future as well.
One more thing: I wouldn't mind seeing a regular dividend of some sort, plus I would expect a blue chip stock to be less volatile than its industry peers.
Buy and hold vs. buy and sell
Now let's get to the "holding them for the long haul" part of your question. A lot of investors misunderstand what constitutes a true "buy and hold" strategy. If you mean "buy and hold" as opposed to "buy and quickly sell" -- that is, invest with the idea of unloading the stock for a quick profit -- then, yes, I think that's the right way to think of buying blue chips, or even smaller, more volatile stocks for that matter.
RELATED ARTICLES
|
|
|
|
I believe investors should buy stocks only if they have a long-term investing horizon. Warren Buffett, aka the Wizard of Omaha, has said that his preferable holding period is forever. Well, you don't have to go that far, but you should do enough analysis on a stock so that you feel its future prospects are solid enough that you would be comfortable holding onto it for several years.
But some investors have come to think of buy and hold as buying a stock and then sticking the shares in a vault somewhere and forgetting about them. I guess the idea is that they're so comfortable with the research they've done on the stock or so confident of its prospects, that they don't have to revisit their decision. This isn't buy and hold. This is insanity.
Don't buy and forget, however
I don't care how blue of a blue chip a company is. You can't buy a stock and then forget about it. You've got to monitor its progress. Is it living up to expectations? Does it continue to dominate competitors in its core business, or is it slipping? Has it expanded into new areas where it's encountering problems because it lacks expertise?
Blue chips don't always remain blue chips. Just think of Xerox, a once hallowed company that's fallen on hard times the past few years. Indeed, you may even want to consider paring back your position in a blue chip because the stock has done too well.
That's right. Maybe everybody loves your blue chip so much that its price has been bid to absurd levels, in which case it's probably become a larger portion of your portfolio. So if for no other reason than to prevent your portfolio from becoming too dependent one stock, you may need to sell some shares and reinvest the money in other parts of your portfolio.
So by all means make some nice solid blue chips part of your portfolio. To find companies that are worthy of the term blue chip, you can start in the Investor Research Center on our web site and also check out the stock screeners at sites such as Morningstar and Quicken.
But remember to diversify broadly across industries and, most importantly, to keep tabs on any companies whose stock you end up buying. And if what seemed to be a true blue color begins to fade, don't hesitate to re-evaluate your decision, and jettison the stock if things have changed for the worse.
Walter Updegrave is a senior editor at MONEY Magazine and is the author of "Investing for the Financially Challenged." He can be seen regularly Monday mornings at 7:40 am on CNNfn.
|