So What Does 'Blue Chip' Mean Anyway? Why No Stock Is Truly Safe

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 |  Includes: DIA
by: Skyler Greene

A little while ago, I realized that SeekingAlpha's founder and CEO David Jackson had commented on my article Intel: A Pretty Rockin' Stock You Should Buy Right Now. As usual, a lot of the commenters had great analysis and varying opinions. Fellow SeekingAlpha contributor J.D. Welch had this to say about Intel (INTC) and Microsoft (MSFT):

I don't consider Intel or Microsoft to be typical "tech" companies anymore. With their established dividends and dividend growth histories, solid balance sheets, FCF and cash on hand, they're more blue chips with a shot at decent growth than what we typically expect from hi-growth tech companies. In other words, they've grown up and don't play in the same space as other tech companies do any more.

CEO Jackson's response to Welch's statement was:

Tech is characterized by frequent disruption. Even when companies seem to have reached maturity and strength they can find their markets disrupted by newcomers. NOK was an example of this - it was clearly a "blue chip" tech stock a few years ago. Same with the mainframe players, and non-cloud enterprise software companies like SAP might be facing a similar issue now.

Buffett has said he doesn't invest in tech, I think because as a long term investor he looks for companies with "moats" that can persist for decades. Perhaps it's the same issue as this one.

I agree with both of them, despite the fact that they were, at first glance, disagreeing. They're not, really - they're just interpreting the same words in different ways, and it all boils down to the real definition of "blue chip."

Let's start by analyzing what "tech" really means.

So What Is "Technology" Anyway?

Investors have an unfortunate tendency to occasionally bastardize words. Whenever someone says "tech" in the investment community, our minds automatically jump to one of two related categories:

  1. Computers
  2. The Internet

Yet this is an incredibly narrow view. Google tells me that technology is properly defined as "the application of scientific knowledge for practical purposes." When Buffett says he doesn't invest in tech, he's lying - he means he doesn't invest in internet and computers. But Buffett does invest in "the application of scientific knowledge for practical purposes." Buffett invests in oil companies like ConocoPhillips (COP). Guess what? Oil rigs are an example of technology. Buffett holds a position in American Express (AXP). Guess what? Credit cards count as technology too.

What This Means For Investors

I agree with Jackson's statement that "tech is characterized by frequent disruption" using the implied "investing" definition of tech. Yes, competition and the innovation race are perhaps more fierce in the computer world than in any other industry. But is this a problem unique to the tech sector? No. As I established above, technology is omnipresent - and disruptions in technology almost so.

To illustrate the point, consider the case of Ford (F), which was certainly disruptive to the horse-and-carriage industry back in the early 1900s. Ford's business is transportation technology. Now what if tomorrow, Tesla Motors (TSLA) came out with an equally disruptive technology - say, a new engine design that simultaneously achieved 500 hp and 250 mpg, that Tesla could put in a car selling for $10,000. This would obviously sink Ford and every other auto company out there. Impossible, you say? Well, "flying machines are impossible," said many to the Wright Brothers. The truth is that we don't know what may happen in the future and how that may affect companies in various markets.

While the automotive industry is a fairly easy mental exercise, let's try one that's a little more thought provoking. What if, when you woke up tomorrow morning, scientists had designed self-cleaning clothing? That would mean the end of all laundromats, and it would also do a number on the top line of Whirlpool (WHR) and Procter & Gamble (PG), which make washing machines and Tide detergent respectively - both items that would no longer be necessary with self-cleaning clothing. Even in areas seemingly diametrically opposite from "technology" - like, say, retail - we see that technological disruption is a powerful force. While retailers like Best Buy (BBY) used to seem like great and safe bets, the rise of e-tailer Amazon (AMZN) clearly took a bite out of that idea.

Indeed, it seems to me that no industry or company is safe from the horrors of technological disruption. (If you have a different opinion, or can provide a counterexample, I'd love to see it in the comments section.)

So What Is A Blue Chip Anyway?

Even someone who knows nothing about investing has probably heard of the Dow Jones Industrial Average (DIA). In fact, for many people on any street not named Wall, the Dow is probably synonymous with the concepts of the stock market and investing.

The Dow is indeed the blue chip of blue chips, holding 30 companies that just about everyone recognizes:

3M (MMM), Alcoa (AA), American Express, AT&T (T), Bank of America (BAC), Boeing (BA), Caterpillar (CAT), Chevron (CVX), Cisco Systems (CSCO), Coca-Cola (KO), DuPont (DD), ExxonMobil (XOM), General Electric (GE), Hewlett-Packard (HPQ), The Home Depot (HD), Intel, IBM (IBM), Johnson & Johnson (JNJ), JPMorgan Chase (JPM), Kraft Foods (KFT), McDonald's (MCD), Merck (MRK), Microsoft, Pfizer (PFE), Procter & Gamble, Travelers (TRV), United Technologies Corporation (UTX), Verizon (VZ), Walmart (WMT), and Walt Disney (DIS).

With such illustrious names - and as an index of the 30 most representative blue chips around - you'd think the Dow would have a steady composition, right?

Not really. Check out a history of the Dow components. A lot of those components... are now defunct. According to Wikipedia:

The components of the DJIA have changed 48 times in its 116 year history, and only General Electric remains in the index.

So essentially, your grandfather's grandfather's Dow was not your grandfather's Dow. And it certainly isn't your Dow.

Here's the point of the whole article: no stock, company, or business model is truly safe. We live in a world that constantly changes. We constantly have to reimagine ourselves as we move from job to job, life stage to life stage. Companies have to do the same.

And what does blue chip actually mean? Again referencing Wikipedia:

According to the New York Stock Exchange, a blue chip is stock in a corporation with a national reputation for quality, reliability and the ability to operate profitably in good times and bad.

Thus, no, investing in blue chips doesn't mean you're 100% protected against technological innovation - you can never be 100% protected against progress. What investing in blue chips DOES mean is that you're investing in a company with a strong record, rather than a company with a "long shot." (And guess how the famed Peter Lynch did investing in long shots? 0-for-25.)

Conclusion

It's easy to look back in hindsight and draw conclusions about how you should've invested. (Oh, mobile killed the PC. Oh, the internet killed brick-and-mortar. Oh, the car killed the buggy.) But the truth is, hindsight is 20/20, and unless you have a crystal ball or a time machine, foresight is a lot hazier. It's impossible to predict what disruptive technologies might be invented in 25 years, but that can't, shouldn't, and doesn't stop you from investing in companies that are strong today. Being afraid of technological innovation is irrational - strong and well-managed companies with a history of adapting to changing environments have a good chance of being the ones that come up with the radical innovations that will change our lives. Besides, if you construct a well-diversified portfolio, chances are you'll do extremely well over the long term regardless of a few failures.

To go full circle back to the original back-and-forth about tech: I agree with J.D. Welch. Microsoft and Intel are certainly in a hypercompetitive industry, but that shouldn't discourage you from investing in them. Computers and the internet are an inseparable part of our lives, and this bond will become even stronger over the long term. Microsoft and Intel have been around long enough to prove that they can grow and adapt no matter what challenges they're faced with. That's why they're blue chips, and that's why they're the best bet you have. In investing, nothing's a sure thing - but if you're consistently betting on the repeat champions, I sure like your odds.

Disclosure: I am long INTC, CSCO, F, MSFT, JNJ, PG, BAC, WMT, KO.