What are Large Cap Stocks: Advantages and Disadvantages
The Indian stock market has over 5,000 publicly listed stocks. However, not all securities are the same and perform equally. Thus, to distinguish these securities, analysts use market capitalisation to measure companies and understand their aggregate value. Based on market capitalisation, companies can be small-cap, mid-cap, or large-cap. This article explains large-cap stocks in detail.
What are large-cap stocks?
Large-cap stocks are usually well-established and dominant companies in their respective industries as their market capitalisation is over Rs. 20,000 crores. The term “cap” in large-cap refers to market capitalisation.
Large-cap companies tend to be well-known names with solid reputations for producing quality goods and services. Typically, they have operations beyond the country and expand in different sectors. As these companies look to grow, they look to acquire smaller companies or merge with competitors of similar size. Yet, growth prospects for large-cap stocks are lower than for small- and mid-cap stocks, which are still gaining market share.
The trade-off is that large-cap stocks are less risky and less likely to experience significant price volatility. Thus, experts consider large-cap stocks a more conservative and safe investment choice than small- and mid-cap stocks.
Features of large-cap stocks
Large-cap stocks come with the following standard features.
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Risk:
Large-cap stocks have a healthy financial infrastructure and are more resilient to market volatility. As a result, large-cap stocks react conservatively to market fluctuations. These stocks are not as risky as mid-cap and small-cap stocks. Large-cap stocks are most likely to continue operations without facing the risk of bankruptcy during market downturns. -
Return:
Large-cap stocks are established and mature companies that provide modest and stable returns. These large, financially mature companies pay dividends to investors, contributing significantly to the returns these stocks offer. -
Cost:
Large-cap stocks are often called blue-chip stocks and are more expensive than mid and small-cap stocks. -
Transparency:
Large-cap stocks have been around for decades. Their prolonged track record and established business have increased investor confidence. Investors can analyse a company's performance over time and witness how the stock has performed under different market scenarios. -
Volatility:
These companies are well-established and financially stable, with extensive supply chain networks. They remain constant throughout the business cycle, making them less volatile than the other market cap categories. -
Liquidity:
As mentioned earlier, large-cap stocks are blue-chip stocks with widespread popularity. This popularity, combined with all the above features, makes it far more liquid than other stocks listed on the exchange.
How to evaluate large-cap stocks?
Equity investments are risky and can be tricky. Evaluating any stock before you invest your money is advisable. Before investing in large-cap stocks, you should keep company-specific and industry-specific comparisons in mind. You can check the following company-specific factors.
Management Quality
A company is only as good as its people. Management quality review means that the company's people undergo background checks. Consider checking the following aspects.
- Senior management and promoter experience in this field of executive compensation
- Promoter participation pattern
- Any bad news for operations
- Approach to decision making.
Such factors allow quality control of management. You can find all relevant news with a simple internet search.
Corporate governance
Corporate Governance means all the rules and practices to operate or control a company. Corporate Governance is essential for understanding a company's management quality. For many experienced shareholders, it is not enough for a company to generate profits.
- How well can a company align the interests of shareholders, employees, customers, investors, etc.?
- Where principles of honesty, ethics, and integrity are followed
- Fraud or cheating that may have occurred in the past
To rate stocks in India or any other country, you must conduct an ethics check.
Finance
Once the base is ready, check the company's financial situation. Be careful if the company is heavily indebted and headed for bankruptcy. Not all form of debt is bad. Thus, it is wrong to look at debt only in absolute terms. You should also check the company's debt repayment history. If the company can show a good performance here, it will likely be able to pay off its debt in the future.
- Consider ratios such as debt-to-equity and interest coverage ratios.
- See the price-to-earnings ratio (PE), which indicates whether a stock is undervalued.
- Keep an eye on sales growth (income from sales) to know if your business is doing well. It tells you about the returns stocks can generate.
- You can see the history of the company's dividend payments.
- Where is the company going? Do you expect continued growth?
You must evaluate all the above parameters in the past and project them into the future. Even if there is a gap, if the management is solid and the financial situation has been good for a long time, it is quite possible (but not guaranteed) that the company will continue to thrive in the future.
Additionally, consider looking at the bigger picture in the industry’s future. Suppose you want to invest in Britannia Industries. The analysis should go beyond examining Britannia Industries in the FMCG sector. Industry-level information is also readily available. The industry-specific factors include the following.
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Peer-to-peer comparison:
It is essential to compare a company's performance to its competitors in the same industry. You can't judge a bank's debt by comparing it to its IT company's debt. All industries perform differently. Therefore, you should compare your parameters only with peers' financial data. -
Fluctuations:
You need to see how the management weathered the economic ups and downs. And how did the company thrive during the downturn and weather the macroeconomic storm? The answer to these questions will help you evaluate the stock appropriately.
Why should you invest in large-cap stocks?
Large companies are reputable and trustworthy, generating stable revenues. Therefore, the greatest advantage of investing in large-cap funds is low risk and high stability. Large-sized investment trusts are not significantly affected by market fluctuations and have lower volatility than small- and medium-sized investment trusts.
Initially, the returns may appear low in the short term, but large-cap funds produce better returns over the long run. Investors are safer in making these investments during economic downturns and market/business downturns.
Advantages and Drawbacks
Large-cap funds have many advantages, allowing investors to benefit from investing in historically well-performing companies. The advantages of investing in large-cap stocks include the following.
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Investment stability:
These companies have solid business plans and are financially stable, resulting in constant growth and earnings. Independence from drastic market fluctuations ensures portfolio stability. -
Dividend yield:
Large organisations pay dividends and contribute to the wealth accumulation for investors. -
Capital appreciation:
As the large-cap program invests in promising companies known for their high performance, mutual fund prices do not fluctuate significantly. Hence, investors see high capital growth over the long term. -
Informed investment decisions:
Large companies are established and have been in functioning well for a long time. It is easy to know specific details about these companies, such as profitability, investment experience, financial statements, and operations. -
High liquidity:
Stocks with large market caps can provide high liquidity. Therefore, it is easy to liquidate funds in times of need without incurring losses. It can be crucial for volatile stocks. -
Resist recession:
Large-cap stocks can thrive during uptrends and weather market turmoil. It's a great way to weather a recession without hurting your investment prospects. -
Diversification across multiple sectors:
A large-cap segment is a great option for diversifying beyond market capitalisation because it invests in blue-chip companies. Furthermore, investors do not need to invest in every sector or monitor performance all the time.
Although these companies are resilient, they take longer to recover than mid and small-sized companies. Additionally, mid-and small-cap stocks offer higher returns at higher risk than large-cap stocks.
Who should invest in large-cap stocks?
Large-cap stocks are suitable for investors who make equity investments wisely. Investors disinterested in volatile or wildly fluctuating returns want investment stability. However, you must remember that even the best large-cap funds may not deliver the returns expected in the market compared to mid-cap or small-cap stocks.
Large-cap may also consider rebalancing investments to a bigger portion of their investment portfolio to add the desired continuity (from an investor's perspective) to their investment profile.