Large-cap stocks are what many people refer to when they speak of a “flight to safety.” During periods of volatility even aggressive investors may shift their portfolio towards investments that offer stability and transparency. Those are the two primary benefits to large-cap stocks.
Although some analysts may disagree on what defines a large-cap stock, they are generally thought of to be the stocks of companies that have at least a $10 billion market capitalization. A distinguishing quality of large-cap stocks is they generally deliver quarterly profits and many return a portion of those profits to shareholders in the form of a dividend.
Many large-cap stocks fall into the category of blue-chip stocks. This gives them a beta of around 1. This means that during a bull market, large-cap stocks are not known for market-beating growth. However, all of the FAANG stocks are large-cap stocks so large-cap stocks are not without volatility.
For that reason, while large-cap stocks merit a position in any portfolio, the size of that position will depend on the age and investing style of individual investors. Younger investors and/or those investors with a high-risk tolerance and growth as their primary goal may choose to have a larger position in mid-cap or small-cap companies.
What is a large-cap stock?
When you think about investing in large-cap stocks, the phrase bigger is better comes to mind. However, in the case of a large-cap stock better is in the eye of the beholder. Many value-oriented investors enjoy the relative stability that comes from these quality stocks. However growth-oriented investors may find that large-cap stocks don’t provide enough capital growth for their investing style.
And there’s a reason for this. Large-cap stocks are generally mature companies with strong financials. These companies reliably turn a profit on a quarterly basis. And many of these companies return some of that profit to shareholders in the form of dividends. Dividends are a reliable source of income and can increase total shareholder return over time. However, they do serve as a brake of sorts on the overall growth of a company’s stock.
In this article, we’ll take a closer look at large-cap stocks. In addition to listing the characteristics that define large-cap stocks, we’ll also look at how large-cap stocks are similar to blue-chip stocks. This includes the fact that many large-cap companies pay regular dividends. And because no investment is without risk, we’ll take a look at a few disadvantages of large-cap stocks.
The generally accepted Wall Street rule is that a large-cap stock is that of a company or corporation with a market capitalization of over $10 billion. Market capitalization (i.e. market cap) is a measurement of a company’s total market value.
The formula for calculating market capitalization is to multiply a company’s stock price by the number of shares outstanding. This means that a company that has a stock price of $75 and has 2 million shares outstanding would have a market cap of $150 million ($75 x $1,000,000).
By this metric, over 90% of the equities on United States stock exchanges fall under this category. The Dow Jones Industrial Average and the S&P 500 are two market indices that follow large-cap stocks.
Many large-cap stocks share the following characteristics:
- A high degree of transparency – The vast majority of large-cap companies provide all the required filings with the Securities & Exchange Commission (SEC) and issue regular earnings reports. This allows investors to not only find but analyze public information about the companies they are interested in.
- They may pay a dividend – Large-cap companies are typically in the mature phase of their business cycle. This means that many large-cap stocks pay dividends.
- Large, stable companies – Because of their size, these companies generate predictable, stable revenue and earnings. The reason for this is that these stocks tend to have a correlation with the broader market. And large-cap companies tend to be market leaders. This gives them the resources to take innovative ideas from concept to creation.
- You’re frequently investing in what you know – While not a guarantee of investment success, there is a benefit to investing in companies that have well-known brands. In fact, a tenet of Warren Buffett was to invest in companies who have businesses you understand.
- Large-cap stocks are easily accessible – large-cap stocks are easy to buy and sell. This helps ensure adequate volume so that you can buy or sell a stock when you desire.
- Diversification - The size of large-cap companies frequently gives investors exposure to multiple sectors in one stock. For example, an investment in a company like ExxonMobil (NYSE: XOM) gives investors exposure to the oil and gas sector as well as the commodities market and the renewable energy sector.
- Many ways to invest - Large-cap stocks can be invested in as part of an index fund or an exchange-traded fund (ETF). These funds can allow investors to invest in particular sectors (e.g. financial, technology).
Are large-cap stocks the same as blue-chip stocks?
The accurate answer is they can be, but not always. In general, analysts use a $5 billion market cap as the minimum point for a blue-chip stock. However, fundamental and technical analysts agree there are no specific financial metrics that automatically turn a stock into a blue-chip stock, nor does a stock’s intrinsic value suggest that it falls into the blue-chip category. With that said, most blue-chip stocks are large-cap stocks because of the way they behave.
However since the market cap is the only specific criteria for defining a large-cap stock, not all large-cap stocks are blue-chip stocks. For example, all of the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google) are large-cap stocks. In fact, Apple and Amazon have two of the largest market caps on the market.
Many large-cap stocks pay a dividend
Most, but not all, large-cap stocks have a history of paying a dividend. And those that do frequently make dividend growth a primary goal. One of the reasons this is possible is because large-cap companies typically have rock solid balance sheets.
When looking for dividend stocks, investors can follow the advice of Ben Graham, author of The Intelligent Investor. Graham said that conservative investors should look for stocks that have a 20-year history of returning dividends. Many large-cap stocks meet this criterion. In fact, many large-cap stocks are also considered dividend aristocrats. This means the company has increased its dividend for at least 25 consecutive years.
In addition to providing a source of reliable, stable income an advantage of dividend stocks is the ability to reinvest dividends. This can produce a higher total return for investors than stocks that don’t pay a dividend.
Disadvantages to large-cap stocks
As mentioned earlier, large-cap stocks have a place in almost every portfolio. However, there are some disadvantages that investors need to weigh when deciding how large of their portfolio to allocate to large-cap stocks.
Better suited for buy-and-hold investors – Buy-and-hold investors would not see this as a disadvantage. However, investing today is increasingly weighted by investors who are seeking to profit off a quick trade. This is because large-cap stocks may not move as rapidly as a more nimble small-cap stock. To profit off large-cap stocks usually requires buying shares and holding them over time.
This brings up another potential disadvantage for growth investors. Large-cap stocks generally do not produce outsize returns. This is because they generally correlate with the broader market. Once again, this is not a disadvantage at all for value investors, but many of today’s younger investors are looking for growth, not value.
A more pertinent concern for some investors is that it is more difficult for large-cap companies to pivot their organization to take advantage of changing market conditions.
How to invest in large-cap stocks
Investors can buy individual large-cap stocks or they can take advantage of the benefits of investing in mutual funds or exchange-traded funds (ETFs) that focus on large-cap stocks. This is a good way for novice investors to benefit from the benefits of this sector without having to pick and choose individual stocks.
The final word on large-cap stocks
Large-cap stocks deserve a place in every investor’s portfolio. However, like any investment they should not be the only stocks, particularly for younger investors who generally have a higher risk tolerance. For these investors, a path to wealth may include small cap and mid-cap stocks.
Although large-cap stocks are commonly thought of as being blue-chip investments, all of the high-flying FAANG stocks fall under the category of large-cap stocks.
There are many advantages that large-cap stocks offer. But there are a few drawbacks that depend on an investor’s personal investing style. For value investors, the fact that many of these stocks pay dividends can help investors generate income.
Novice investors or investors who are contributing to a 401(k) or other retirement accounts should consider investing in mutual funds or exchange-traded funds (ETFs). This allows them to get tax advantages while still getting exposure to this diverse sector.