Investing in Large-Cap Stocks

If you’re like most investors, you probably already own some large-cap stocks. These are stocks of companies with a large market capitalization (the cap in large cap). They’re so named because they’re larger than small-cap and mid-cap stocks.

We say that a stock is a large-cap stock when the total value of all of the company’s shares outstanding, meaning the shares held by all shareholders, including company insiders, is greater than $10 billion. (The very largest large-cap companies, with market caps over $200 billion, like Amazon (NASDAQ:AMZN) and JPMorgan Chase (NYSE: JPM), fall into this bracket. Some investors think of them as a separate category of stocks, but for most purposes, they’re just jumbo large caps.)

Large-cap stocks are often thought of as the stalwarts or blue chips of the stock market. Think of companies like Walt Disney (NYSE:DIS), Coca-Cola (NYSE:KO), and General Motors (NYSE:GM) -- long-established giants with dominant positions in their industries.

While many investors find smaller, fast-growing companies particularly exciting, large-cap stocks can be very profitable opportunities for investors who take the time to understand them. And because these mammoth companies tend to be less volatile than their smaller siblings, they can also help diversify a portfolio of smaller stocks while still providing good growth over time. Their principal advantages are that they are safer and more established than smaller companies, usually with reliable profit streams.

However, those assets also mean that large-cap stocks are generally mature companies with moderate growth prospects. Therefore, investors looking for high growth and big potential returns from their stocks may prefer smaller companies or stocks at the low end of the market-cap range.

Here’s a closer look at what large-cap stocks are, how to choose the best ones, and how to decide whether they’re right for your portfolio.

Source: The Motley Fool

Large-cap companies are typically older and well established, and they usually pay reliable dividends. Not all are household names, but many are. Some large-cap companies are blue chips, meaning they’re very stable businesses with respected management teams, strong credit ratings, and a long history of growth. Others, generally industrial giants, are cyclical, meaning that their profits and stock prices tend to move up and down with the overall economy’s cycles. Some are even fast-growing companies that may have been small-cap or mid-cap companies just a few years ago.

The chart below shows the performance of the benchmark large-cap index, the S&P 500, together with the S&P Mid Cap 400 and the small-cap Russell 2000, over the last 15 years through the end of 2019.

As you can see, while large caps might not have been the best performers over shorter periods, they’ve delivered good, steady performance over the long run.

Five great large-cap stocks and funds to consider

Here are some excellent large-cap stocks to consider:

• Starbucks (NASDAQ:SBUX) has historically outperformed the broad market since its 1992 IPO, and looks poised to continue gaining market share despite setbacks from the COVID-19 pandemic. Starbucks is a good example of a large-cap stock that offers both growth, with opportunities in China, digital, and delivery, and a reliable profit stream, as it has considerable competitive advantages, including its well-known brand, popular rewards programs, and tech initiatives like Mobile Order & Pay. The company started paying a dividend in 2010 and has raised it every year since, which potentially sets it up to be a future Dividend Aristocrat.
• MercadoLibre (NASDAQ:MELI) is Latin America’s largest e-commerce site and a great example of a large-cap company that is still growing quickly. Think of it as a combination of eBay (NASDAQ:EBAY) (because it features listings from third-party merchants) and Amazon (because it’s building its own shipping network) -- with a twist. The twist is the company’s payment tool, MercadoPago. Originally a PayPal-like service for MercadoLibre shoppers, it has grown to become something of a multinational bank for Latin Americans, who use it to make payments at grocery stores and gas stations.
• Procter & Gamble (NYSE:PG) is an excellent example of a blue chip large-cap company. This dominant maker of soap, detergent, toothpaste, and other consumer staples is also a Dividend Aristocrat, meaning that it has raised its dividend annually for at least 25 years in a row. Procter & Gamble has raised its dividend every year for 56 years in a row through 2019. In true blue chip fashion, it’s very well managed, too: Despite its huge size, P&G has managed to post earnings growth in recent years, thanks to constant work to improve its efficiency.

You can also choose to add the benefits of large-cap stocks to your portfolio by investing in a fund that focuses primarily on large-cap companies.

• Vanguard S&P 500 ETF (NYSEMKT:VOO) is an exchange-traded fund that tracks the performance of the S&P 500 Index, a leading index of large-cap stocks.
• Fidelity Contrafund (NASDAQMUTFUND:FCNTX) is a mutual fund that invests in large-cap and megacap stocks, typically focusing on large-cap stocks with the potential for earnings growth over time. It’s actively managed, meaning that the fund’s manager is aiming to beat the performance of the S&P 500 Index rather than match it. Actively managed funds like the Contrafund tend to have higher fees than index ETFs, with the idea that in exchange for higher fees, the manager will deliver performance that beats the index to cover the difference.

How to evaluate top large-cap stocks

Great large-cap stocks come in different flavors. Some are former small-cap growth stocks that just kept growing, like MercadoLibre; some are longtime players in industries that are difficult to build scale in, like Starbucks; and some are dominant giants with long traditions of strong management and steady growth, like Procter & Gamble.

Just about any top large-cap stock will have easy-to-see competitive strengths, strong brands, proven leadership teams, and a track record of taking care of investors -- through dividends, share-repurchase programs, or simply delivering growth over a long period.

They’ll also tend to have a recent history of earnings growth, a strong dividend, or both.

Earnings growth

A stock’s price tends to follow the company’s earnings over time. If earnings are growing steadily, the stock’s price will tend to rise steadily as well. Although past earnings growth doesn’t guarantee more growth in the future, a strong company with a track record of earnings growth will generally be a good bet for investors.

While earnings growth typically means that a company’s sales have been growing, that isn’t always true. Some large-cap companies have been able to generate growth in earnings by becoming more efficient over time. Those companies can be good investments, too.

Note that cyclical companies won’t always have recent records of earnings growth, because their earnings tend to drop as the economy slows. That doesn’t mean they’re bad investments -- for those companies we take a longer-term view. We want to see that their earnings and profit margins during economic expansions have been improving over the long haul, and that they’re prepared to weather downturns without drama.

Dividends

Dividends, the periodic payments that many companies make to distribute profits to their shareholders, can be a large-cap investor’s secret to growth. The key here is to reinvest the dividend: Instead of taking the dividend in cash, use it to buy more of the stock, effectively adding growth over time. (Most brokerages can do this for you automatically, at no charge.)

Just remember that companies tend to cut their dividends when they hit rough patches. If you’re going to rely on the company’s dividend for growth, make sure you’ve done enough research to understand the company well before buying.

Are large-cap stocks for you?

If you can hold an investment for five years or more and you’re comfortable with the ups and downs of the stock market, but you want investments that can give you smoother performance versus volatile smaller stocks, then large-cap stocks might have a place in your portfolio. Conversely, if your portfolio is dominated by volatile growth stocks, large caps might be just what you need to diversify while still getting good growth.

Remember that while large-cap stocks are often companies that “everybody knows,” it’s still important to do your homework before you buy.

If you’re not sure that you want to do the research required to evaluate individual large-cap stocks, you can still get the benefits of large-cap stock investing by adding a large-cap ETF or mutual fund to your diversified portfolio.