What are Large Cap Stocks: Features, Advantages and Drawbacks

Large cap stocks in India are shares of well-established companies with significant market presence. Known for their relative stability and steady growth potential, they form the foundation of many investment portfolios. This article explores the key features, advantages, and limitations of large cap stocks to help investors evaluate if they align with their financial goals and risk preferences.

• Table of contents

• What are large cap stocks?
• What are some features of large cap stocks?
• How can we evaluate large cap stocks?
• Who should invest in large cap stocks?
• Reasons to invest in large cap stocks
• Advantages and drawbacks of large cap stocks
• Alternatives to large cap stocks

What are large cap stocks?

As the name suggests, large cap stocks are the country’s top stocks in terms of market capitalisation. Market capitalisation (or market cap) refers to the total value of a company’s outstanding shares, calculated as current share price multiplied by the total number of shares.

As per regulatory norms, in India, large cap stocks are those that are listed between 1 and 100 on recognised stock exchanges. Mid cap companies are those listed from 101 to 250 and small caps are companies listed 251 and beyond.

What are some features of large cap stocks?

Typical characteristics of large cap stocks include:

• Large market presence: As discussed, large cap stocks have significant market share.
• Reputation: They are usually well-known companies with a record of strong performance, robust business models, competitive market positions and strong leadership.
• Lower volatility: These stocks tend to be relatively less volatile than stocks of smaller companies and can reduce downside risk in volatile times.
• Dividends: Many large cap companies are cash-rich and have the potential to pay relatively consistent dividends.
• High liquidity: Large cap stocks in India are actively traded on stock exchanges in high volumes, making buying or selling relatively easy, reducing liquidity risk.

Also Read: What are large cap mutual funds?

How can we evaluate large cap stocks?

Here are some factors investors can consider when investing in large cap stocks:

• Financial strength: Review the revenue, profit, and cash flow numbers and their year-over-year (YoY) growth rates to judge the financial health of the company.
• Valuation: Check whether a stock is overvalued or undervalued by using ratios like P/E (price-to-earnings), P/B (price-to-book), and dividend yield.
• Leadership: Evaluate the pedigree of the senior leadership of the company by checking their track record and performance.
• Industry position: Check whether a company has built a defensible market position, and competitive advantages over its peers (known as an economic moat).

Investors can also invest in large cap stocks through mutual funds, where the stock selection and portfolio management are handled by an investment professional. Large cap mutual funds focus predominantly on large cap stocks, while other mutual fund categories (multi cap funds, large and mid cap funds etc, value funds etc) may offer exposure to large as well as small and mid cap stocks.

Who should invest in large cap stocks?

Large cap stocks can be suitable for investors who seek the long-term growth potential of equities but with lower volatility. They may also be suitable for first-time investors with limited knowledge of the market.

Reasons to invest in large cap stocks

In addition to long-term return potential, large cap stocks can potentially limit downside risk during periods of volatility. Also, some large cap companies have a track record of paying regular dividend income, which can contribute to cash flows for those seeking the potential periodic payouts. With significant institutional ownership and strong brand trust in sectors like banking, telecom, FMCG, and IT, large caps carry credibility and familiarity, large caps can be used to build a core portfolio.

Advantages and drawbacks of large cap stocks

Here are some advantages of large cap funds:

• Lower volatility: Large cap stocks are generally perceived to carry lower risk than mid and small caps. They have the potential to offer relatively stable returns in the long term due to their established business models and competitive positioning. However, they are not immune to market downturns.
• Liquidity: Large cap stocks typically witness high trading volumes, which means that investors can typically enter or exit positions relatively easily. This reduces liquidity risk.
• Reputation: They have long-standing brand recognition and market presence.
• Dividends: Some large cap companies have a history of paying consistent dividends, which can be useful for those seeking the potential for regular income. However, it is important to note that dividend payments are made at the company’s discretion, and a past record does not guarantee future payouts. Factors such as market conditions, company profitability, and evolving business strategies can influence dividend decisions.

Drawbacks

However, there are certain drawbacks to consider as well:

• Limited growth potential: They might not offer the growth potential that certain mid or small cap stocks do and are better suited for relatively steady long-term growth.
• Higher valuations: Large cap stocks can sometimes be overvalued due to high demand and brand premium.
• Lag in bull markets: These stocks may underperform mid or small caps during bull runs.

Alternatives to large cap stocks

While large caps can form the foundation of a good portfolio, investors can also look to diversify into other segments to potentially capture different market opportunities.

• Mid and small cap stocks: Small cap stocks are high-risk instruments with high return potential. Mid cap stocks strike a balance between the relative stability of large caps and the high volatility of small caps. Combining all three in a portfolio can help investors create a more optimal balance between risk and return potential.
• Index Funds/ETFs: These are relatively low-cost funds that track indices such as the Nifty50 or the BSE Sensex. Their returns are directly related to these indices and by extension, the broad market.
• Thematic mutual funds: Sector-specific mutual funds (tech, energy, infrastructure focused) offer a way to invest in a specific industry without being overexposed to one particular large cap stock.

Also Read: BSE Largecap for Stable Investment

Conclusion

Large cap stocks often form the core of many portfolios, offering relatively stable performance, strong fundamentals, and the potential for long-term returns. However, their relatively stable nature may not suit every investor, especially those seeking aggressive returns. The key is to align large cap exposure with your personal risk tolerance, financial goals, and time horizon. Combining them with mid and small caps can create a balance between risk and return potential.

FAQs

How much should I invest in large cap stocks?

It all depends on your risk appetite and preferences. Equity investors on the lower end of the risk spectrum may have a large cap heavy portfolio, while those that are more aggressive may find mid and small caps more suitable.

Are large cap stocks risky?

While large cap stocks are generally considered less volatile than smaller companies, but are still subject to market risks and economic fluctuations. As equity investments, they are classified as high risk.

What is large cap and mid cap in the stock market?

Large caps are the top 100 companies on the stock exchange by market cap, whereas mid caps are 101st to 250th and small caps are companies ranked 251 and below in terms of market cap.