Investors looking to build a portfolio of stocks or supplement their portfolio of index funds with individual stocks (known as “core-and-explore”) would be wise to stick with the largest, most well-known companies in North America. Known as blue-chip stocks, these companies tend to be leaders in their respective industries and offer indispensable products or services.
Blue-chip stocks have a number of characteristics that appeal to investors.
- They tend to be large and highly profitable businesses (industry leaders)
- They often pay (though not always)
- They’ve been in business for a long time (often 100 years or longer)
- They sell products or services that everyone has heard of (and consumers can’t live without)
- They tend to have the highest trading volume (popular stocks to buy and sell)
- Their stock performance tends to be safe, reliable, and predictable (often beating the broader market)
The term blue-chip stock comes from poker, where blue chips have the highest value. On a stock exchange, the term blue-chip can be subjective (there is no definitive measurement); however, the companies with the highest market capitalization or value tend to be referred to as blue-chip stocks.
How Safe are Blue-Chip Stocks?
Investors flock to blue-chip stocks for the perceived safety and dependability of their returns. Indeed, large-cap stocks do tend to have strong performance and lower volatility than smaller stocks or more growth-oriented stocks.
What gives blue-chip stocks these incredible market-beating traits? It’s not a blue-chip company’s size that explains its strong returns. Instead, it’s the exposure to known risk factors such as value (where stocks trading at a high book-to-market ratio outperform stocks trading at a low book-to-market ratio), and profitability (where stocks with high profitability outperform stocks with low profitability).
Since blue-chip stocks tend to be large, profitable companies that trade at lower multiples than smaller growth stocks, the majority of a blue-chip stock’s returns can be explained by their exposure to the value and profitability factors.
Does this make blue-chip stocks safe? Not exactly. Even large-cap value stocks that pay dividends will fall out of favour and fail to beat the broader market. Look no further than iShares’ Canadian Select Dividend ETF (XDV), whose top holdings contain the bluest of blue-chip Canadian stocks, including:
- Canadian Tire
- Bank of Montreal
- Royal Bank
- Bank of Nova Scotia
- Toronto Dominion
- National Bank
- TC Energy
- Sun Life Financial
- Power Corp
- Rogers Communication
Compare the returns of XDV with the returns of the broader Canadian stock market, represented by iShares’ Core S&P/TSX Capped Composite Index ETF (XIC). XIC holds many of the same blue-chip Canadian stocks as XDV, but with notable exceptions like Shopify (SHOP), Barrick Gold (ABX), and Constellation Software (CSU).
The difference in the make-up of these index ETFs has meant a significant difference in returns. Since 2006, the blue-chip ETF XDY has a total return of just 14.51% compared to the broader Canadian market (XIC), which has a total return of 43.56% over the same time period.
Who Should Invest in Blue-Chip Stocks?
There’s a growing number of investors who prefer to build their own portfolio of Canadian blue-chip stocks while getting their U.S. and international stock exposure through low-cost ETFs. Why?
Canada’s stock market is relatively small, representing just 3-4% of the global market capitalization. The TSX is represented by just 60 of the largest companies in Canada, most of which are heavily concentrated in three sectors – financials, energy and mining.
Investors can “skim” the top 20 or so blue-chip Canadian stocks and buy them individually, rather than paying even a small ongoing management fee to hold them in an ETF (the MER for XDV is 0.55%, while XIC has a MER of 0.06%).
Investors who follow a dividend approach should invest in blue-chip stocks and not stray into picking obscure or unknown companies, or companies that fail the profitability test and are at risk of cutting their dividends. Blue-chip stocks tend to be reliable dividend payers.
Most investors should simply stick with low cost investing with index funds or ETFs. But for those who want to build their own stock portfolio, investing in a diversified portfolio of blue-chip stocks can be a good approach to building wealth.
Top Picks for Blue-Chip Stocks
The top blue-chip stocks in Canada will likely be in the financial, communications, and energy sectors. All six of Canada’s big banks fit into the “blue-chip” category, as do all three major telecom companies, and our largest utility and pipeline companies.
Here are my top blue-chip stocks for Canada:
- Financial (Banking): Royal Bank (RY) – Canada’s largest bank also happens to be the largest stock in Canada with a market cap near $400 billion.
- Industrials: Canadian National Railway (CNR) – The largest rail company in Canada has been in business for nearly 100 years and transports $250 billion in goods annually.
- Energy: TC Energy Corp (TRP) – TC Energy has operated pipelines, storage facilities, and power-plants across North America for more than 65 years.
- Communications: BCE Inc (BCE) – BCE (formerly Bell Canada) is by far Canada’s largest communications company and is worth approximately $139 billion.
- Financial (Insurance): Manulife Financial (MFC) – Manulife is a multinational insurance company that was founded more than 130 years ago in 1887.
- Consumer Discretionary: Canadian Tire (CTC.A) – Canadian Tire has a long tradition in Canadian retail dating back nearly 100 years (founded in 1922). Its market cap is more than $100 billion.
- Utilities: Fortis (FTS): You can’t have a Canadian blue-chip stock list without including Fortis. As reliable as they come, Fortis has increased its dividend payment every year for 44 consecutive years.
For an in-depth analysis, read more about the top blue-chip stocks in Canada.
How to Invest in Blue-Chip Stocks
Today, investors have never had an easier or more affordable time to build their own stock portfolios. Discount brokerage accounts used to charge $29 per trade. Now you can buy (and sell) stocks for free using Wealthsimple Trade‘s stock trading platform.
If I were going to invest in blue-chip stocks and build up my portfolio, I would use Wealthsimple Trade to save on commissions and fees. There’s no sign-up fee and no minimum account size. Just sign up and start trading today. Here’s an excellent reason to sign-up: those who open a Wealthsimple Trade account will get a $50 cash bonus + $0 commission trades. All you have to do is deposit and trade at least $150.
Wealthsimple Trade does have some limitations, namely, its platform doesn’t offer the most robust performance data and research capabilities. Also, for those who want to buy U.S. blue-chip stocks, Wealthsimple Trade will charge a currency conversion fee when you buy U.S. stocks in Canadian dollars. (It does not allow clients to hold USD.)
Investors looking for more versatility would be smart to open a Questrade account. Our top pick for online brokerage in Canada, Questrade lets you buy stocks for as low as $4.95 per trade, and you’ll get $50 in free trades when you open an account today. For further research, you can read our comparison of Wealthsimple Trade vs. Questrade.
Once you’ve selected your trading platform of choice, you’ll want to come up with a stock-picking strategy. Again, the term “blue-chip stock” is subjective.
The good news is you can screen for stocks with the highest market cap by sector (like my top picks listed above), or look for stocks that meet several criteria such as large market cap, a dividend yield greater than 2%, and a low price-to-book ratio (screening for value).
You can also avoid certain stocks or sectors by applying a negative screen to exclude stocks with a high dividend payout ratio (signalling lower profitability).
The key is to find an approach that works for you and then sticking to it over the long-term.
Picking individual stocks is generally not recommended as a long-term investment strategy. There’s an overwhelming amount of academic and empirical evidence that shows why active management (stock picking and market timing) underperforms passive management (investing in low-cost index funds).
Still, if you have a stock picking itch to scratch, you could do worse than selecting a diversified basket of blue-chip stocks. Companies with these characteristics (large, profitable, dividend-paying, low book-to-market) can deliver strong returns and even outperform the broader market for long periods of time.
Canadian investors can “skim” the top blue-chip companies to form the Canadian equity component of their portfolio and avoid paying any ongoing management fees. This approach is generally paired with investing in index funds for U.S. and international stock exposure.
Finally, don’t just blindly follow a list of names you know (remember Kodak?). Instead, do your own research to screen for and identify blue-chip stocks that meet your criteria. Don’t stray from it and go chasing stocks with unsustainable dividend yields, or small stocks that don’t meet your “blue-chip” definition.
A portfolio made up of strong, profitable, blue-chip companies is a portfolio built to last.