What are Large-Cap Stocks?
Large-cap, or large capitalization, stocks belong to large, established companies with a high market capitalization. These stocks are often considered the safest of all equity investments.
A stock that’s referred to as a large-cap is a stock that’s issued by a company with a market capitalization of $10 billion or more.
Common Characteristics of Large-Cap Stocks
There are many large-cap stocks out there. So before investing, identify yourself with their common characteristics of them.
Here’s an overview of the characteristics that many large-cap stocks share:
- Dividend
The majority of large-cap companies pay dividends to their investors. This return is in addition to the return they earn through price appreciation. Examples of large-cap companies which pay dividends are Pfizer (PFE), Coca-Cola (KO), and IBM (IBM).
- Growth and Profitability
Another key feature of large-cap companies is growth and profitability. These are companies that have strong fundamentals and have established themselves as market leaders. Essentially, these are the blue-chip stocks. These are companies that are financially sound and have a track record of consistent growth and profitability, representing stability.
- Good Management
Large-cap companies demand good management without which they cannot survive. Therefore, every large-cap company has management teams and leadership boards that often have years of combined experience. The quality of the management team is one way to gauge the strength and growth outlook of a large-cap firm.
- Information readily available
All large-cap companies have a wide array of information available publicly for investors to review and analyze. Their public reports offer a degree of transparency that can be helpful when making buy and sell decisions for a particular stock.
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Pros and Cons of Investing in Large-Cap Stocks
PROS
One of the most common reasons for investing in these large-cap stocks is their long history of successful business operations and proven business models that enable them to stay successful and maintain their status in their respective markets or industries.
The following are the specific benefits of large-cap investing:
- Established Companies Provide Stability and Security
Investing in large-cap stocks provides investors with relative security over their investments. Most large-cap companies are leaders in their markets or industries. By investing in them the investors reduce the overall risk of their portfolio.
- Tested and Proven Model and Management Capabilities
Larger and more established companies have remained in business because of their business models. These organizations have a more sophisticated approach to management and leadership. Both their effective business models and management capabilities can give investors a sense of assurance that their investments are handled well.
- Higher Liquidity Than Small-Cap and Mid-Cap Stocks
Large-cap stocks represent a significant portion of the stock market. And their daily traded volume is also considerably high. This means that these stocks are more liquid than small-cap stocks and mid-cap stocks. Investing in large-cap stocks lowers the liquidity risks that come with stock investing.
- Source of Passive Income
The dividend payouts of large-cap stocks are stable and consistent. The majority of these stocks are also some of the top stocks for passive income.
- All the information is out there
Large-cap companies publish detailed reports such as financial statements, annual reports, and strategic directives to keep their investors and stakeholders informed and stay transparent. Also, it helps investors make calculated decisions with all the information readily available.
CONS
The soundness of their business models and overall stability also draw unique issues. Here, let us discuss the disadvantages of investing in large-cap stocks:
- More Exposure to Global Economic Downturns
Investing in large-cap stocks exposes an investor to systematic risks that come from global economic affairs. A major source of revenue for large-cap companies is global sales. Also, these companies are highly dependent on global trade both for their sales and supplies. A disruption in the global supply chain or an economic crisis that affects different geographical markets can affect the performance and profitability of these organizations.
- Restricted Potential for Substantial Growth in Investments
Another disadvantage of large-cap stocks is that they have limited potential for sky-high capital appreciation. These are already well-established in the market and they undergo a steady growth pattern Therefore, an investor seeking exponential growth in these companies will be disappointed.
- Expensive Stock Price
Since these companies have years and years of business history and have proven themselves continuously, the price of their stock is also comparatively very high. Therefore, not every investor can afford to buy a good amount of shares in these companies.
- Lower Possibility for Significant Ownership and Control
Large-cap stocks limit the issuance of common stocks and prefer issuing preferred stocks to prevent a hostile takeover. Therefore, for investors looking for a significant level of ownership and control, this is not a suitable investment. Furthermore, because of their higher market capitalization, it is impossible to gain control without spending huge amounts of money.
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Finding the Best Large Cap Stocks
Finding the right large-cap stock for one’s portfolio highly depends on the investor’s needs, interests, attitudes toward risk, and other factors.
- Always do your homework
Always check financials and current news reports to see how the company has been doing. Also, study the reports from analysts and take a look at the history of dividends or stock buybacks to see how value might be transferred to owners.
- Rightfully identify the company’s business
Large-cap companies are usually involved in a wide variety of operations which makes it difficult for investors to identify in which business the company operates. The company might have exposure to multiple industries and geographic regions, adding diversity to its portfolio without having to explicitly invest in different sectors.
- Not all Large-cap stocks are a safe investment
Large and stable does not usually mean safe investments. Therefore, always conduct your research, look at the company’s competitive position, understand the industry dynamics, study the competitors, understand the financial well-being of the company, look at the dividend track record, and study the future growth prospects and overall market prospects.
While there is no guarantee of any company to be one of the best large-cap stocks to invest in and no single stock is necessarily right for everyone, here are some examples of large-caps to consider:
- Berkshire Hathaway (BRK-B) – Owned by the legendary investor Warren Buffett, the company’s long-term view of investing has proven to be successful, a decade in and out.
- Microsoft (MSFT) – The company’s key highlights are solid financial footing and a diverse product lineup, including Windows, Azure, Office 365, and gaming
- Starbucks (SBUX) – Despite recent controversies of labor disputes, Starbucks has proven to be the top performer in the market and even came out strong after the COVID-19 disaster.
What are Small Cap Stocks?
The term “small cap” is used to identify stocks that have a market capitalization of between $300 million and $2 billion. Small-cap stocks are issued by smaller companies. You can find small caps in virtually any stock market sector, including healthcare, finance, and tech.
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Pros and Cons of Investing in Small-Cap Stocks
PROS
There are many good reasons why investors choose small-cap stocks to become a part of their portfolio:
- High Growth Potential
A small company has great growth potential and expected many years of growth and price appreciation. All large-cap companies like Amazon and Facebook were once small-cap stocks that underwent huge growth consistently to achieve their large-cap status today.
From an investor perspective, that means investing in small-cap stocks also offers the opportunity to invest in an upcoming large-cap stock
- Less Competition From Institutional Investors
Institutional investors include banks, hedge funds, and real estate investment trusts. These are entities that pool money to invest on behalf of individual investors.
Majority of the institutional investors choose not to invest in small-cap stocks just because of their size. Additionally, federal regulations block them from investing heavily in small caps. As a result, the majority of small investors are drawn towards small-cap stocks with the hope of seeing a smaller company grow over time.
- Better Returns Compared to Large Caps
Small-cap stocks offer better returns to investors on their investments. Historically speaking, many small-cap stocks have outperformed larger companies when it comes to average annual returns
Small-cap companies are more accommodating and can easily make changes to adjust to the changes in the overall market and develop and launch new products or services, or undergo an internal restructuring if necessary. All this contributes towards the small-cap being a better performer.
- Low Price of stocks
The price of the small-cap is usually. This is majorly due to fewer demands, stocks from smaller companies are relatively inexpensive and more accessible than mid-cap and large-cap stocks
CONS
No investment is risk-free. Every investment comes with its challenges and risks. Therefore, always consider the cons and/or disadvantages of every investment before investing:
- High Volatility
Small-cap stocks tend to be more volatile. Even when the whole market is volatile, small-cap stocks get more exposed to volatility than other stocks. If a smaller company has less access to investment capital or is still new and experiencing its business model, it can potentially become more volatile. Therefore, be aware of the risk of volatility before investing.
- Limited Liquidity
Small-cap stocks tend to be less liquid because of their size. When a company isn’t as well-known, you may find fewer people who own shares to buy from and similarly fewer buyers when you want to sell.
- Less Transparency
The challenge with small caps is that there tends to be less information available publicly. This is a huge hurdle for investors who fail to gather enough information about the potential investment to make an informed investment decision.
- Investing in Startup and Smaller Companies has its issues
Smaller companies tend to be less insulated from market volatility, as well as greater market and economic downturns. Also, these companies have just started they lack experience or any history to learn from. And not to forget their business model is still in the process of trial and test. Therefore, creating more issues in day-to-day operations.
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How to Invest in Small-Cap Stocks?
Before investing ins mall cap stocks, be aware of the few ratios which help identify good small-cap stocks.
Evaluating small caps means looking at some key metrics, including the ones below.
- Earnings and revenue growth – Studying the earnings and revenue growth help investors predict the future growth of the company. A small-cap company might not be profitable today but if it has a steady revenue and earnings growth rate, chances are it might do well in the future.
- Earnings per share: This calculation refers to a company’s profit, divided by the number of shares of outstanding common stock. This tells about the potential profit an investor earns over his investment in the company.
- Price-earnings ratio (P/E): The price-earnings ratio is a way to measure a company’s value, based on how the current share price compares to earnings per share. A stock with a lower P/E ratio could be undervalued, which could be a bargain-buying opportunity. A higher P/E ratio could hint that the company’s stock is overvalued.
- Price-sales ratio (P/S): This ratio represents market cap divided by revenue. If a small-cap company doesn’t have any earnings per share to report, you can substitute this ratio instead to measure its performance against other small caps.
Large-cap vs Small Cap. Which to choose?
| Sr. | Type | Large-Cap Stocks | Small-Cap Stocks |
| 1 | Valuation | Companies valued above $10 billion | Companies valued between roughly $250 million and $2 billion |
| 2 | Stability | Typically viewed as more stable | Typically viewed as more volatile |
| 3 | Growth Potential | Less potential for significant growth | More potential for explosive growth |
| 4 | Dividends | More likely to pay dividends | Less likely to pay dividends |
| 5 | Stocks price | High stock price | Low stock price |
Valuation
Large-cap stocks generally are issued by any company worth $10 billion or more, while small-cap stocks come from those worth between $250 million and $2 billion.
Stability
Larger cap companies have been in business for many years and have more financial resources at their disposal. Therefore, they are better built to manage all downturns and issues that come their way. As a result, their operations are stable and that is how the investment in large-cap stocks is considered.
Small caps are usually businesses that are new and still growing experiencing. They have less access to financial resources and suffer more during a financial downturn or any other business issue.
Many investors use the market cap as a gauge of risk and stability. However, there is no guarantee in any business that which will flourish and which will suffer.
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Growth Potential
If a company has attained large-cap status, that typically indicates that the business is relatively mature and established. There’s less room for it to grow. Whereas, small-cap companies offer huge potential for growth.
Dividends
Large-cap stocks are more established and are more likely to pay dividends. The reason being they don’t need to reinvest all of their profits. However, small caps do not pay dividends as they need all the money they can afford to reinvest in the company.
Stock Price
Large-cap stocks are usually very expensive and not everyone can afford to buy a good number of shares. Whereas, small-cap stocks are just new to the market and trading at very low prices.
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CONCLUSION
Large and small-cap stocks both are different forms of investment but both have a different result.
Large-cap stocks have slow and steady growth potential. Investing in large-cap stocks is not ideal for day trading or quicker buy-and-sell transactions. These stocks are better suited for income-seeking and value-seeking investors who prioritize buy-and-hold investing or passive investment strategy over active investing or traders involved in frequent trading activities.
Small-cap companies are a higher-risk, higher-reward stock investment. They have more growth potential, but also more chances for failure if things don’t go well. However, for investors with limited funds, small-cap stocks are best suited as they are cheaper. Also, be careful with the commission fees, and remember to keep a check on it. Regular trading of small-cap stocks might pile up high commissions and can erode all profits.
Investors at the beginning of their trade journey should invest a decent amount of money in small-cap stocks. It will help them understand how market volatility works and how the high-risk high reward function works. However, for investors seeking a safe investment which generates passive income large cap stocks are the best bet.
Both type of investment provide results as long as investors take caution with their investments and make informed decisions. Also, every investment should be in line with the investor’s financial goal to avoid any sort of disappointment.
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