How do Blue Chip shares and Dividend shares work?
Last week I looked at penny shares and was, in the eyes of some readers, rather scathing about them. It’s not to say penny shares won’t grow (every share was a penny share once), more that your chance of picking the 1% of winners rather than the 99% of duds, is slim indeed. Precisely the opposite obtains for Blue Chip and Dividend shares. But first, let’s define what we’re talking about here.
Among the definitions I found in a quick search for ‘blue chip shares’ are ‘Shares of a company known for its ability to make profits and which pay a dividend in good times or in bad.’
Then there is ‘shares in quality, stable companies that have paid regular dividends in both good and bad years’. We’re talking about the giants of the stockmarket, companies that have been around for decades, like BT, British Airways and Marks & Spencer. We’re talking BP, Barclays, Royal Dutch Shell and Vodafone, companies with market capitalisations in the billions of pounds, and with share prices not in the pennies but the pounds.
And these are the shares that the penny share buyers avoid. Why? Because you’ve missed the boat, they will say. There is no way that BT or HBOS is going to rocket in value in the way a new company will. These are solid, dividend yielding shares, and people make them the bedrock of their share portfolios for just that reason … they will deliver slow and steady growth over the years.
That’s not to say that blue chips can’t be volatile. Anyone looking at bank shares at the moment, particularly the hapless Royal Bank of Scotland, might figure that the gig is up.
RBS is down From around 530 pence a year ago to around 250 pence a share now. Venerable Barclays down from more than £7 to less than £4. BT Group has dropped from 320p to around 220p in the same period, while Vodafone has seesawed from 160p up to around 200p to end up … well pretty much back where it started a year ago.
So why bother buying them? Well first of all you’re not buying M&S or BT shares to sell them a year later - you’re buying them to hold, to give you that slow and steady growth we talked about. And over time all those little (or even large) blips in the price graph will even out - you’ll forget all about them. You also won’t waste time checking the share price each day and you won’t waste money on trading commission, beacuse you won’t be buying and selling them.
The FTSE 100 index, the hundred companies quoted on the London Stock Exchange with the largest capitalisations, started in 1984 with a value of 1000p.
It’s soared and plunged from time to time and is going through a rocky period just now. Nonetheless in June 2008 it stands just above 6000p.
And while there have been a number of companies ejected from the FTSE down the years, the collapses have been few and far between. There was the infamous Railtrack failure and the collapse of British and Commonwealth. Generally though, these giant companies have been swallowed up by even bigger ones - Bank of Scotland into HBOS, Enterprise Oil into Royal Dutch Shell, the biggest of them all.
So failure is rare, and even if growth is slow and steady and boring, that’s only half the story.
Maybe your stock is only climbing 5% a year, but these blue chip shares will pay a dividend - give you an income in other words.
The super rich, those fortunate souls who inherited a couple of million in stocks from their grandpa, may never buy or sell their shares but simply live off the income from dividends. Because even if the share price drops, the blue chip companies are almost certain to still pay the dividend each year.
If you, rather than spending that income, simply invest it in more stock, then that’s where REAL growth kicks in. And over the past century, the markets have delivered around 9% a year … ASSUMING investors reinvest their dividends.
NOW … that 9% compounds each year. That would mean that if I popped £7,000 (which is the current yearly ISA limit) into shares at age 30, and ignored them till I retired at 60, I would pick up around £90,000. More realistically, pop 7k into my ISA for each of those 30 years and my £210,000 investment will be worth 1.1million. I haven’t bought or sold, as these are shares to hold, so I’ve minimal dealing costs.
Many successful investors have profited from this ‘buy and hold’ policy, not least Warren Buffett, who obviously knows a thing or two.
There’s more to it than that of course - with Buffett also being a past master at value investing, looking for shares that he believes are fundamentally undervalued.
But after that, it’s buy, hold and watch yourself grow rich. Rather than chasing the dream of penny shares you could do much worse than making dividend yielding blue chips the bedrock of your investment portfolio.
In future editions of Walletwatcher, I’ll also be looking at how to find value shares, and how to identify high yielders … to make the pot grow even faster. Next week, as credit gets crunched harder I’m going to be looking at some creative ways to raise the mortgage you want.
Links: Stockmarket overview and live prices
Tags: Blue chip shares, Dividend shares, Financial budgeting, Stockmarkets, shares, personal financial advice
