Most investors understand the importance of diversification through asset allocation within a portfolio, which is meant to balance out the risk and reward trade-off between equity, debt and cash holdings. Under the equity or stock positions within a portfolio, however, investors have a wide array of investment options, each with different characteristics, advantages and disadvantages.
A large-cap stock investment, defined as the stock of a company with a market capitalization of $10 billion or more, is common among both growth and value investors as a portion of an overall asset allocation. Large-cap, or big-cap, stocks have unique advantages for investors, including stability in size and tenure, steady dividend payouts to shareholders and clarity in valuations.
- Large cap stocks are valued at greater than $10 billion in the market, making them more stable and mature investments.
- As a result, large cap stocks typically have lower volatility, greater analyst coverage, and perhaps a steady dividend stream.
- At the same time, they may have less growth potential and may lag the broader market in a bull swing.
The greatest advantage to adding large-cap stocks to an investment portfolio is the stability they can provide. Because large-cap companies are so large and have a well-established reputation with consumers, they are less likely to come across a business or economic circumstance that renders them insolvent or forces them to stop revenue-producing operations completely. Companies that are considered small- or mid-cap do not have the same level of stability, and therefore carry a greater degree of risk than large-cap investments.
Another advantage to investing in large-cap companies is the potential for steady dividend payments. The stock prices for large-cap companies are not typically slated for high rates of growth over time because they are already well-established in the market. This can create a stagnant stock price and little-to-no capital appreciation for investors. However, despite the lack of rapid growth in terms of stock price, large-cap companies often pay dividends to compensate shareholders. These dividends can lead to impressive comprehensive returns for large-cap investors when they are added to the performance calculation over time. Large-cap stocks that pay steady dividends are common among income investors or those seeking income through relatively conservative investing.
Research and Valuation
Because large-cap companies often have a long business tenure, investors and creditors can easily obtain research on company operations and profitability levels. Publicly traded large-cap companies are required to provide shareholders and potential investors with accurate and periodic financial statements, allowing for ease in determining whether a company is worth the investment. In addition to research, company history and financial statements can be used in combination with current business activity to determine accurate valuation. These aspects play an important role in understanding the risk and potential reward of investing in a large-cap company.
Investors can use the Russell 1000 Index to find and evaluate large-cap companies, as this index compiles approximately 1,000 of the largest companies in terms of market capitalization operating within the United States. Large-cap investments can be purchased as individual shares of stock; through an exchange-traded fund, or ETF, that tracks a large-cap benchmark; or through one of the hundreds of available mutual funds focused on large-cap investments.
What the Experts Say:
Robert Schmansky, CFP®
Clear Financial Advisors, LLC, Livonia, MI
Large-cap stocks tend to be companies that are established in their markets with long-term histories. Some feel this makes them “safer” to invest in.
Larger company stocks also often pay dividends, allowing you to capture some of the return of your investment, which some investors view as a benefit. Rather than keeping their profits and investing it back into themselves, they may not benefit as much from using the cash, so they distribute it to owners.
Smaller companies have benefits as well. They can add diversification benefits to traditional portfolios which tend to be market-capitalization weighted (they invest more in large-cap stocks to better represent their share in the market).
Smaller companies have more room to grow; an investment that a small company makes may double their revenue. Meanwhile, that same investment by a larger company may not make a noticeable difference.
Overall, you should invest in a mix of stocks that represents your time horizon and tolerance for risk, including both small and large company stocks across the globe.