Last Updated on May 24, 2022 by Aradhana Gotur
The Indian stock market very distinctly categorises its listed companies on the basis of their market capitalisation. Each category has its own features and drawbacks, giving investors a choice to make informed decisions. The most stable, established, and reputed stocks with large capitalisation fall under the category of large cap stocks.
This article extensively covers the features, advantages, and risks associated with large cap stocks.
Table of Contents
What are large cap stocks?
Stocks are categorised based on their market capitalisation. Market capitalisation refers to the total worth of a company. A company’s market capitalisation is calculated by multiplying its total shares outstanding to its share unit price in the current market.
There are three categorisations: large cap, mid cap, and small cap. Large cap stocks, also known as blue-chip stocks, are the shares issued by a company with large market capitalisation – over Rs. 20,000 cr.
Securities and Exchange Board of India (SEBI) categorizes the large cap stocks within the top 100 companies on the stock exchange. These stocks make up most of the equity market.
Large cap companies act as market leaders, and even small movements in their stock price can impact the broad market because of the weightage and proportion of the overall market that large cap stocks occupy. These companies are known for stable earnings and hence enjoy a preferred status, especially among new investors and the risk averse investor’s investment portfolio.
Why do investors buy large cap stocks?
Following are the primary reasons that investors make large cap stocks a part of their investment portfolio:
Stable portfolio
Blue-chip stocks provide stability to the portfolio since they are not very easily affected by market sentiment. They can balance the risk in the portfolio effectively. A large cap company is rarely insolvent and hence can be an excellent option for hedging.
Regular dividends
Blue-chip stockholders generally receive regular dividends more often than not.
Greater analyst coverage
Large cap companies in India are obligated to disclose their financials publicly. There is also more analyst coverage of large cap stocks in general. Interested investors then can decide to invest in blue-chip stocks based on the reports. Hence, investors have enough comprehensive information to compare large cap companies’ performance.
The importance of large cap shares
Large cap stocks have the potential to resist and digest economic downturns. They remain mostly immune to market turbulence and can win the ups and downs of market cycles, recovering quickly without endangering the business sights.
Role of market capitalisation in investment portfolios
Stock markets run in cycles, constantly affecting the performance graph of different capped stocks. When the economy declines, small-caps usually help it recover. And when mid cap or small caps plunge, large cap stocks can bring stability to your overall returns.
By focusing on market conditions, a diversified investment portfolio with different capped stocks can be significantly profitable.
Features of large cap stocks
- Large cap stocks are the stocks of the top 100 companies in the country that are large, matured, and well-established, making up most of the equity market.
- These stocks are less risky as their price continues to be stable even amid economic turbulence.
- These stocks are a stable investment option for an investor with a longer investment horizon.
- These are expensive stocks, thus require substantial capital.
- These stocks have higher liquidity as they can be bought or sold quickly without a much-affected price.
How do large cap stocks work?
Large cap companies are well-known players in the economy with a sound financial track of years. Their stocks provide returns slowly and steadily over the long term. As compared to other caps, these stocks are less risky and ideal for investors with low-risk profiles.
Financial factors to be considered while investing in large cap stocks
The following are the fundamental financial factors one may consider before investing in large cap companies:
- A low debt to equity ratio
- High return ratio
- High-interest coverage ratio
- Company’s ability to generate cash flows consistently
- Industry trends to grow significantly in the years ahead and sync with the economy
- Quality of management and business
How to make money by investing in large cap stocks?
Large cap stocks do not typically fluctuate too much and offer long-term capital appreciation opportunities. Despite the lack of accelerated growth in well-established large cap companies, they usually pay heavy dividends that compensate shareholders. These stocks are also an excellent option for conservative investors who do not want to expose their capital. Furthermore, these fundamentally strong stocks can help a beginner build an investor’s core portfolio that offers stability.
Limitations and risks of large cap stocks
Expensive stocks
You require substantial capital to invest in large cap stocks with a resolve to stay invested for several years. An individual with low disposable income may not have such financial stability. Thus, every individual may not be able to afford these stocks. Take for example, a blue chip stock trading at Rs. 2,000. In such a case, only a lump sum amount invested could garner gains for the investor.
The low potential for capital appreciation
Low capital appreciation is one of the serious limitations of investing in large cap companies. Large cap stocks are not responsive to market fluctuations; therefore, their price movement is slow, even in a bull market.
Conclusion
Large cap stocks are shares issued by large cap corporations that are backed by a long history of strong financials and market trust. They heavily influence the direction of markets and the economy, given the weightage they command in the broader market. They make a good choice for portfolio allocation as they are less vulnerable to market changes and more often than not provide regular dividends.
Nevertheless, one should invest only after considering their investment objectives, risk profile, and investment horizon.
