Blue-chip stocks represent large (by market capitalization) companies. Therefore, they are considered to be safe, reliable, and established for stable growth in the market. On the other hand, speculative stocks, whether they are small-cap or “penny stocks,” are more defined by their unknowns and their potential future growth. So, which among the two stock categories is safer?
Blue chip stocks are safer to invest in than speculative stocks. These companies have a proven business model and have a track record of delivering sustained proven growth. Contrarily, speculative stocks are new companies or meme stocks. While they can deliver exponential returns, this potential comes at much higher risk.
Though “safer” here doesn’t mean guaranteed returns or that blue-chips won’t experience downturns in their share price. Read on to learn more about some of the conceptual differences and important risk factors to consider when investing in either blue-chips or speculative stocks.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
Size Does Matter: Market Capitalization
Simply put, a stock’s market capitalization is a good (but not perfect) measure of its potential risk and reward (or safety). According to Investopedia, market capitalization refers to the total dollar market value of a company’s outstanding shares (or all the shares currently owned by shareholders and available for trade).
For example, a company with 10 million outstanding shares currently selling for a market price of $100 per share would have a ‘market cap’ of $1 billion.
Market cap is ultimately a relatively simple concept to understand: the more outstanding shares there are and the higher their price, the higher the market capitalization.
Market cap thus provides a metric to compare the size of companies based on what the investing public — individual investors (people), institutional investors (corporations, mutual funds, governmental entities), and banks alike — thinks they are worth.
It’s a popular metric for investors to use because it’s easy to calculate and understand, and provides perhaps the best indicator of the risk-reward ratio for a given investment. In general, the higher a company’s market cap, the safer it is to invest in — i.e. less likely to lose significant share price in a short period of time.
If you rank stocks by their market cap, it basically delivers a list of the most recognizable brands in the world: Apple, Microsoft, Coca Cola, Boeing, and so on. A large percentage of blue chip companies are tech giants, given their huge user bases and enormous revenue streams.
These largest and most well-known companies have the highest market capitalization and have become known as “blue-chips.” The name comes from poker, where the blue-colored chips are typically known to have the highest value at the table for the purposes of betting.
The largest companies are the most likely to have the best asset capacity, liquidity, and economies of scale to handle the market’s cyclicity, thus maintaining or growing their share price over time. As a result, their investments are less volatile, i.e. safer.
Note that market capitalization isn’t the same as the company’s total asset value, or its enterprise value (EV).
Such figures as asset value and enterprise value represent the actual capital at work within these entities (ex: Tesla’s EV factories, Google’s server farms, all tech co.’s intangible assets such as Intellectual Property (IP) rights, etc.). On the other hand, market capitalization is purely a stock market figure determined by investor trading volume and sentiment around the company.
Though due to the efficiency of markets and the heavy trade volume around the largest companies in the world, market cap and enterprise value do end up at similar valuations. For example, viewing their Yahoo Finance valuation page as of 6/30/21, Apple’s market cap was around $2.27 trillion and its enterprise value was actually a bit higher, at $2.32 trillion.
In all, blue-chip stocks are usually considered to be those with the highest market capitalization. They’re the most heavily traded, feature a global market reach with billions of dollars in revenues, and are typically the most recognizable brands in the world. As a result of all these factors, blue-chips are the safest kind of stock market investment to make.
That being said, when making an investment decision, never lose sight of the fact that safety is always a relative term in the stock market.
Speculative Stocks Are Trading for the Future
The primary heuristic to understand when comparing investments, such as between blue-chip stocks and smaller speculative stocks, is that the latter are much more dependent upon the future. That’s what speculative means!
By definition, speculative stocks are much riskier, meaning that the market value of the stock may sharply drop without warning and never recover. At the same time—and to justify their existence at all—speculative stocks also feature higher growth potential.
In essence, the difference between the blue chip stocks and the speculative stocks comes in their respective track records: proven vs. unproven.
Blue-chip stocks arrived at their established, market-leading position after their own period of speculation and high growth. There was a time when Google and Apple were considered speculative, unproven assets.
Now, with their high asset value, brand recognition, and consistent revenue flows, blue-chips are much closer to a “steady-state” rate of growth. This means they aren’t likely to grow fast or decline in value quickly from here on out, until market conditions change and dictate something like that.
Speculative stocks, such as small caps or penny stocks (highly volatile stocks that are akin to gambling), feature a much higher degree of risk and reward. Simply, they aren’t proven yet.
Their current share price is based on their future potential growth after their idea has taken off in the market and has buyers, investors, and brand recognition. But right now, none of that is reality yet.
The heuristic between blue-chips and speculative stocks is thus: blue-chip stocks are valued mostly based on present production, whereas speculative stocks are valued mostly based on future production.
Which is more known and thus less risky? The present is here with us and the future is tomorrow.
Building the Right Portfolio
None of the discussion in this post is to say that blue-chips are ‘better’ than speculative stocks.
The amount you invest in blue-chips versus potential high-growth bets comes through in your preferences as an investor. Younger investors are more likely to take higher risks whereas older individuals may want safer options because they can’t afford to lose their savings.
Before entering the stock market, ask yourself: How much risk do you want to take on?
Do you devote 10% of your portfolio to high growth potential bets and 90% to reliable blue-chip brands? Or do go 50/50, with equal shares invested in “the next Apple” as much as Apple themselves? It’s up to you.
It’s never a good idea to invest all your money in high-risk bets with the hope that you’ll make exceptional profits.
Author’s Recommendations: Top Trading and Investment Resources To Consider
Before concluding this article, I wanted to share few trading and investment resources that I have vetted, with the help of 50+ consistently profitable traders, for you. I am confident that you will greatly benefit in your trading journey by considering one or more of these resources.
- Roadmap to Becoming a Consistently Profitable Trader: I surveyed 5000+ traders (and interviewed 50+ profitable traders) to create the best possible step by step trading guide for you. Read my article: ‘7 Proven Steps To Profitable Trading’ to learn about my findings from surveying 5000+ traders, and to learn how these learnings can be leveraged to your advantage.
- Best Broker For Trading Success: I reviewed 15+ brokers and discussed my findings with 50+ consistently profitable traders. Post all that assessment, the best all round broker that our collective minds picked was M1 Finance. If you are looking to open a brokerage account, choose M1 Finance. You just cannot go wrong with it! Click Here To Sign Up for M1 Finance Today!
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Conclusion
Blue-chip stocks, by definition, are ‘safer’ than speculative stocks. However, no investment is ever perfectly safe in the stock market. Safety is about the risk-reward ratio and how much risk you wish to take on to earn your rewards.
Blue-chip stocks are larger and thus grow more consistently given their consolidated capital and market investments built over time. Speculative stocks are typically startup-style operations with a good idea that has yet to fully materialize. Thus, blue-chips are based on the present while speculatives are based on the future.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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