Investing in conservative blue chip stocks may not have the allure of a hot high-tech investment, but it can be highly rewarding nonetheless, as good quality stocks have outperformed other investment classes over the long term.
Historically, investing in stocks has generated a return, over time, of between 11 and 15 percent annually depending on how aggressive you are. Stocks outperform other investments since they incur more risk. Stock investors are at the bottom of the corporate “food chain.” First, companies have to pay their employees and suppliers. Then they pay their bondholders. After this come the preferred shareholders. Companies have an obligation to pay all these stakeholders first, and if there is money leftover, it is paid to the stockholders through dividends or retained earnings. Sometimes there is a lot of money left over for stockholders, and in other cases there isn’t. Thus, investing in stocks is risky because investors never know exactly what they are going to receive for their investment.
What are the attractions of blue chip stocks? 1. Great long-term rates of return.
2. Unlike mutual funds, another relatively safe, long term investment category, there are no ongoing fees.
3. You become an owner of a company.
So much for the benefits – what about the risks? 1. Some investors can’t tolerate both the risk associated with investing in the stock market and the risk associated with investing in one company. Not all blue chips are created equal.
2. If you don’t have the time and skill to identify a good quality company at a fair price, don’t invest directly. Rather, you should consider a good mutual fund.
Selecting a blue chip company is only part of the battle – determining the appropriate price is the other. Theoretically, the value of a stock is the present value of all future cash flows discounted at the appropriate discount rate. However, like most theoretical answers, this doesn’t fully explain reality. In reality, supply and demand for a stock sets the stock’s daily price, and demand for a stock will increase or decrease depending on the outlook for a company. Thus, stock prices are driven by investor expectations for a company, the more favorable the expectations the better the stock price. In short, the stock market is a voting machine and much of the time it is voting based on investors’ fear or greed, not on their rational assessments of value. Stock prices can swing widely in the short-term, but they eventually converge to their intrinsic value over the long-term.
Investors should look for good companies with great expectations that are not yet embedded in the price of a stock.
Stock picking is a very complicated process and investors have different approaches. However, it is wise to follow general steps to minimize the risk of the investments. This article will outline these basic steps for picking high performance stocks.
These three steps should get you started in your quest to consistently make money in the stock market. They will deepen your knowledge about the financial markets, and would provide a sense of confidence that helps you to make better trading decisions.
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