One of the most important elements in constructing any portfolio is to make sure it is diversified. This is accomplished by including equity, debt, and cash holdings in your portfolio. For your equity positions you can further diversify by including different asset classes such as U.S. based, international equity, and REITs. This diversification will help smooth out the movement in your portfolio when there is a great amount of market volatility. With the continued uncertainties and market volatility due to COVID-19 many investors have been increasing their holdings of U.S. large cap stocks in their portfolios.
Characteristics of Large Cap Stocks
Stocks are categorized by the size of their market capitalization which is defined as the total dollar value of a company’s outstanding shares. The standard market cap categories are large, mid, and small caps, although sometimes they are further defined as mega and micro caps. Large cap stocks are defined as companies with market capitalizations of $10 billion or more. They are typically well-known, established companies that have been around for a long time. Two of the three major indices that are tracked and used to determine the health of the overall stock market are comprised of large cap stocks. The Dow Jones Industrial Average tracks the 30 largest U.S. stocks traded on the New York Stock Exchange and Nasdaq. The S&P 500 is comprised of the 506 largest U.S. publicly traded companies.
Dividends – since large cap companies have been around a while, they generally have more cash on hand than smaller companies. These cash reserves allow many large caps to pay dividends, often at steadily rising levels year over year. These dividend payments are an excellent source of passive income for more conservative investors or those nearing or in retirement. As these dividends are also usually quite reliable, they are also another source of income during times of low bond yields.
Less Risk – large cap stocks are generally considered to be the safest equity position to invest in. Due to their size, resources, and efficiencies, large caps are much more likely to weather current storms as they have done many times in the past. They are good investments for long-term growth and predictable, steady returns. This is especially true during times of economic downturn or uncertainty. This is one reason we are currently seeing many investors flocking to large caps in the current investment environment.
Transparency – due to how closely many large cap companies are followed, investors have an easy time obtaining data on their operations, senior management, and profitability. Most of these companies are public and required by the Securities and Exchange Commission to provide quarterly earnings reports and outlooks, financial statements, and many other metrics. Every quarter, analysts scrutinize the data and participate in calls with senior management to discuss the quarterly information. Opinions arising from the financial review can provide insight to the average investor on whether it is an appropriate investment for them.
Lower Earnings Growth – one downside to large caps is that they typically grow at a slower rate than smaller more nimble companies. This is especially evident in an expanding market. If you are an investor who is looking for short-term yield you will likely be disappointed in large caps. They are more suited for investors who are who are using a buy and hold strategy.
Large Cap Growth Stocks
Some large cap stocks do not share all the typical attributes discussed above. Despite being older with steady earnings, some large cap companies do continue to grow their earnings at a brisk pace. These large caps are considered growth companies – names such as Google, Amazon, and Netflix come to mind. Specific financial figures used to determine if a company is considered growth includes future long-term and short-term growth in earnings per share (EPS), 3-year historical growth in EPS, current investment to assets ratio, and return on assets. Due to the focus on growth, these types of large caps will often not offer the steadily increasing dividends discussed above.
Some of my favorite large cap growth funds include:
Vanguard Growth ETF – VUG
iShares Russell 1000 Growth ETF – IWF
Invesco QQQ Trust – QQQ (technology weighted)
Large Cap Value Stocks
Some investors who want the security that large caps offer but would like a higher return, often invest in what are known as large cap value stocks. These stocks are considered underpriced relative to their fundamentals. The fundamentals commonly reviewed to determine if a stock is a value stock are book to price, forward and historic earnings to price, and divided and sales to price ratios. Some companies that are currently considered value stocks include Berkshire Hathaway, Johnson & Johnson Company, and Procter and Gamble Company.
Some of my favorite large cap value funds include:
Vanguard Value ETF – VTV
SPDR Portfolio S&P 500 Value ETF – SPYV
Incorporating Large Cap Stocks into Your Portfolio
Despite their slower and lower earnings growth, large cap stocks do have a place in everyone’s portfolio. The percentage of them compared to small/mid-caps or other classes such as REITs depends on your appetite for risk as well as your timeline as to when you plan to use the funds. Depending on these variables, it could be appropriate to include anywhere from 10 – 50% of your portfolio in U.S. large caps. As discussed above there are different kinds of large caps so including both growth and value stocks in your portfolio is best for diversification. If you do not want to invest specifically in growth or value funds, there are many funds available that offer a mix of U.S. large caps and include both growth and value stocks.
Some of my favorite large cap blend funds are:
Vanguard Large Cap ETF – VV
iShares Russell 1000 Index ETF – IWB
Deborah Hobart, CPA is a Financial Advisor at Blue Water Capital Management, LLC, a fee-only financial advisory firm in Apex, NC.
