The fact that there are thousands of stocks to choose from
leads many investors to experience decision paralysis. What's the
best sector to invest in? What characteristics should one look
for in a company? Are dividends important, or is growth the main
Although these are legitimate questions, there's a better
place to begin your search. If you're on the hunt for a great
company, then why not start with the biggest and best the market
has to offer? In the vernacular of Wall Street, these are known
as "large-cap" stocks.
What are large-cap stocks?
The term itself refers to a company with a large market
capitalization. What does this mean? As Investopedia explains,
it's nothing more than a "fancy name for a straightforward
concept: it is the market value of a company's outstanding
shares." To calculate it, you multiply a company's stock price by
the number of shares outstanding. For example, at the time of
trades for $99 and has 4.3 billion shares of common stock
outstanding. This yields a market cap of $426 billion.
The standard threshold for what constitutes "large cap"
coalesces around $10 billion. This captures well-known companies
, as well as lesser-known concerns such as private-equity firm
The Carlyle Group
, a waste collection and disposal company headquartered in
Complicating the matter is the fact that the
the most widely followed large-cap index in the
, sets the bar lower. To make it onto the index, a company need
only have a market capitalization of $5.3 billion. "The market
cap of a potential addition to an index is looked at in the
context of its short- and medium-term historical trends, as well
as those of its industry," reads the index's methodology
factsheet. "These ranges are reviewed from time to time to assure
consistency with market conditions."
Regardless of the precise threshold, however, these are the
biggest and best companies in America. Many have been in
existence for decades -- some for more than a century. The
largest of the bunch -- the so-called "
" -- are household names with powerful brand recognition and
international operations. They are the titans of their respective
How many large-cap stocks are there?
Any estimate of the number of large-cap stocks depends on how
you define the term. If the threshold is $10 billion, then 428
make the cut as of August 2014. If $5 billion is the benchmark,
then the universe increases to 711.
It's important to note moreover that the number of large caps
is a moving target. As stock prices rise and fall, companies on
the margin can either attain or lose the coveted designation. The
offers a good example. Its market cap over the last three
decades has fluctuated between $19 billion and $2 billion.
What drives large-cap stocks?
There is nothing particularly unique about the forces that
drive large-cap stocks relative to their smaller counterparts.
Generally, all companies are affected by the health of the
underlying economy. And because the United States economy is the
world's largest, it typically exerts the biggest effect.
More specifically, two macroeconomic forces often impact the
performance of the companies underlying large-cap stocks. The
first is unemployment. If people aren't employed, they have less
money to spend, and economies therefore contract. The second
factor is consumer and investor confidence.
Beyond these are a litany of sector-specific factors. For
example, while ExxonMobil and
Bank of America
both benefit from low unemployment, the former's profit is
closely tied to
, while the latter's relies more on the relationship between
short- and long-term interest rates. Along the same lines, people
's tablets and phones unless the products themselves are in some
ways superior to the competition.
What's the advantage of large-cap stocks?
The traditional argument in favor of large-cap stocks is
that they are relatively safe due to their size and
track record. And along these same lines, it's often assumed that
they outperform small-caps during economic slowdowns but
underperform when the economy is expanding. But while this
is generally true, the issue of relative performance is not as
clear-cut as logic seems to suggest.
Consider the chart below. This compares the performance of the
Russell 2000 Index
, which measures the performance of small caps, to the S&P
500, the benchmark index for large-cap stocks. As you can see,
even though the S&P 500 declined less than the Russell 2000
did from the peak in 2007 to the trough two years later, the
difference is relatively nominal. By the same token, even though
the Russell 2000 has outperformed the S&P 500 since then,
it's not ahead by a huge margin.
With this in mind, it's better to think about the advantage of
large-cap stocks in terms of volatility. Volatility is measured
by "beta," which indicates how much a specific stock's price
fluctuates relative to the broader market. Large caps are roughly
half as volatile as small caps. According to data from
YCharts.com, stocks with a market cap above $10 billion have a
median beta of 1.08 compared to a median beta of 2.21 for stocks
with a market cap between $250 million and $1 billion.
Along these same lines, an added advantage is that large-cap
stocks distribute a considerable portion of earnings to
shareholders, while small-cap companies generally do not. These
massive and mature companies are past their high-growth days. In
order to compensate investors for their slow-moving stock prices,
large caps often pay dividends, which they can back up with
large, consistent earnings. Roughly 81% of large-cap stocks pay
dividends versus just 23% of small-cap stocks.
The bottom line on large-cap stocks
When you consider the advantages of large-cap stocks over
their smaller counterparts, it's clear the two serve different
purposes. Small caps cater to investors in search of capital
appreciation. Meanwhile, large caps are better suited for income
investors and those driven by capital preservation. Many
investors invest in some of each in accordance with their goals,
their risk tolerance, and their ideas of what constitutes a
Armed with the knowledge above, consider whether investing in
large caps could help you achieve your financial goals.
Large-Cap Stocks: Investing Essentials
originally appeared on Fool.com.
Try any of our Foolish newsletter services
free for 30 days
. We Fools may not all hold the same opinions, but we all believe
considering a diverse range of insights
makes us better investors. The Motley Fool has a
Copyright © 1995 - 2014 The Motley Fool, LLC. All rights
reserved. The Motley Fool has a