This article talks about large-cap stocks, their features, benefits, and various risk associated with them.
According to a circular issued by SEBI in 2017, large-cap stocks are the stocks of companies which is ranked 1-100 in terms of full market capitalization. These stocks are the 100 largest in the terms of market capitalization listed on the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) of India. The list of top 100 companies gets updated on a half-yearly basis. Generally, the market capitalization of large-stock companies crosses Rs. 20,000 crores. Large-cap stocks usually have stable revenues and earnings in the long run and thus should be a part of everyone’s investment portfolio. Nifty 50 index hosts the top fifty large-cap stocks in India. Some of the large-cap stocks are also known as Blue-Chip stocks, which refers to stocks of those companies which are well-established companies from a particular sector and have stable earnings and the highest market valuation.
Classification of Large-Cap Stocks
Generally, large-cap stocks can be put in the following two categories:
- Large-Cap Value Stocks: These stocks belong to companies that are currently undervalued and have great potential to provide superior returns in the future. Comparison of Price to Earnings (PE) Ratio is used to identify value stocks. The lower the PE ratio of a company, the more undervalued is the stock.
- Large-Cap Growth Stocks: These stocks belong to companies that have the potential to outperform the market over time. These stocks have a high potential to increase their revenue and earnings at a quicker rate than the average businesses in the same industry. These stocks generally have a higher PE Ratio than value stocks.
Features of Large-Cap Stocks
- Low-Risk: Large-cap stocks are less affected by market volatility. The price of such stocks tends to be stable even amid economic turbulence. Thus, the risk on these stocks is significantly lower.
- Liquidity: These stocks have higher liquidity as they can be easily bought or sold without affecting their price substantially.
- Dividend Pay-outs: Large-cap companies usually provide stability but are not nominated for high growth rates as they are already well-known companies in the market. These stocks often provide moderate growth in capital appreciation. But large-cap stocks generally provide the advantage of steady dividend pay-outs.
- Costly Stocks: These stocks are commonly more costly than other investment options and thus require substantial capital.
- Available data for evaluation: Large-cap companies have a long tenure of business which allows investors to analyze adequate data to study performance over past years. These companies hold a rich operational history accessible to the public that repose trust among them.
Why invest in Large-Cap Stocks
Large-cap stocks are an excellent option for conservative investors who are not willing to expose their capital. These stocks have the ability to balance one’s portfolio by reducing risk and providing stable returns. The primary reasons to invest in large-cap stocks are:
- Stable Portfolio: Large-cap stocks offer stability to one’s investment portfolio since they are not easily affected by market sentiments. These companies are least likely to be rendered insolvent even during a bearish market and can thus balance losses suffered by the other securities in the portfolio. These companies can balance the risk in the portfolio effectively.
- Regular Income Source: The main source of income from large-cap stocks is through dividends rather than capital appreciation. Thus, the investors can be sure of a regular flow of income in the form of dividends.
- Great Analyst Coverage: Large-cap companies are obligated to disclose their financial statements and other essential documents to the public. Interested investors can make their decision based on such information.
- Potential to resist economic downturns: These companies mostly remain immune to market turbulences and can thus win the ups and downs of the market cycles. Large-cap stocks have a great likelihood to resist and digest economic recessions.
Risk Associated with Large-Cap Stocks
- Expensive Stocks: A large amount of capital is required to invest in large-cap stocks with a resolve to stay invested for a long-time horizon. Individuals with low disposable income may not have such financial stability and thus may not be able to afford large-cap stocks.
- Low potential for Capital Appreciation: As large-cap stocks are not much responsive to market fluctuations; therefore, their price movement is slow. Large-cap stocks do not provide much scope for capital appreciations.
Factors to consider before investing in Large-Cap Stocks
- Debt-Equity Ratio: A debt to equity ratio measures the amount of debt a company has, compared to its equity. A high debt to equity ratio means a large portion of the revenue of the company is spent on its financial charges. Thus, a low debt-equity ratio is preferred.
- Return Ratios: Return on Equity (ROE) measures the profit generated on shareholders’ equity, whereas Return on Capital Employed (ROCE) measures how efficiently a company utilizes all its available capital in generating profits. A company with high return ratios with steady growth is considered a good company for investment.
- Dividend Yields: It measures the amount of dividend paid to the shareholders relative to the market value of the share. A high dividend is preferred by the investors.
- Operating Profit Margin: It measures the profitability of a company. A company with a positive and increasing operating profit margin is considered for investment by the investors.
- EV/EBITDA Ratio: EV stands for Enterprise Value and EBITDA stands for Earnings Before Interest Taxes Depreciation and Amortization. This ratio helps us to analyze and compare companies in the same industry and determine if a stock is over-priced or under-priced.
- Other Factors: Investors should also consider some other factors before investing their money in a large-cap stock. These factors include but are not limited to the company’s ability to generate cash flows in the future, high-interest coverage ratio, various industry trends, and the quality of the management and business.