Field Guide to Large-cap Stocks

By Tony Custodio
Senior Analyst, mPower

In This Story Joining the Ranks Measuring Performance Large-cap Characteristics What's It to You?

Many areas of the market have seen a reversal of fortune so far in 2000, and large-capitalization stocks and mutual funds are no exception. For five straight years, from 1995 to 1999, the S&P 500 — the oft-cited index representing large-cap equities — returned more than 20 percent per year, gains nearly doubled the historical norm. But, as the end of 2000 nears, with the Index down more than 5 percent, the large-caps look ready to break their winning streak and log negative returns for the year.

Of course, not every asset class can have a good year every year. And, large-cap stocks are still an important part of most investors' asset allocation.

minute: read this article at a glance.

Technical Terms Asset class Market capitalization Standard & Poor's 500 (S&P 500)

First of all, let's define asset classes. They're the categories that your different investments fall into — broad ones include cash, bonds, large-cap stocks, small-cap stocks, and international stocks, though there are a number of more specific permutations. Studies have shown that the key to successful investing is to spread your wealth among different asset classes.

"Cap" refers to a company's market capitalization, or the total number of shares multiplied by the stock's price. This is a gauge of what the market (or investors) believes the entire company to be worth. Generally, companies with a market cap of over $10 billion are classified as large-cap. As of Nov. 13, 2000, General Electric, the largest of large-caps, had a market cap of $510 billion. Market caps change daily, if the stock price changes.

Large-cap stocks are a broad subset of the stock market and they're an important one for retirement savers. According to the Hewitt 401(k) Index, more plan assets are in large-cap stocks than in any other single asset class.

Joining the Ranks

Larger companies tend to have a more established business presence and less uncertainty in sales or profits than smaller (small-cap) companies. Although there are exceptions, larger companies often have slower growth rates and are less risky investments than many smaller companies.

The path to "large-capdom" varies from company to company. As long as the stock price goes up, so does market cap. Historically speaking, stock prices increase as a firm's earnings increase — just how much depends on how much a company can increase its future revenue and earnings or, rather, the market's perception of them.

Juniper Networks, a maker of Internet routers, made its way into large-cap territory very quickly (in less than a year) because investors were willing to bid up the stock based on optimism that its rapidly growing revenue would one day reflect actual earnings. Such a rapid move of stock prices due to investor enthusiasm is an exception, however, and most companies take many years to climb the ranks.

Typically, large-cap companies begin life as small-cap companies. Over many years as public entities, they climb their way up the market-cap ladder as they are able to increase revenue and earnings or, again, the perception of future earnings. Over time, stock prices and market value of companies are driven by earnings growth.

Measuring Performance

Different indexes (or market barometers) are used to represent large-cap stocks — the best known and most widely used is the venerable S&P 500; others include the Russell 1000 and the Wilshire Large Cap 750 Index. Large-cap indexes are rebalanced periodically (usually on a semiannual or annual basis) to reflect the changes in the market values of companies as their stocks increase or decrease in price.

These indexes are often used as benchmarks for mutual funds and pension funds that invest in large-cap stocks. Portfolio managers of large-cap mutual funds usually invest in many of the companies in these indexes; but many also buy stocks outside of the index, or in different proportions, in an attempt to beat the index. Index funds generally include shares of all the companies in the underlying index in an attempt to exactly match its returns.

Large-cap Characteristics

Most large-cap stocks are in the technology, financial services and health care sectors, which makes sense given that these sectors play an ever-increasing role in the economy.

Large-cap technology stocks, such as Intel, Microsoft, IBM, Cisco Systems and Oracle, are among the biggest players in the U.S. and in the world as technology continues to be vital in homes and businesses.

Financial services, also a large sector of the economy, has done very well in recent years in the low-interest-rate and bull-market economic environment. Many large-cap financial stocks, such as Morgan Stanley Dean Witter, American Express and Citigroup, are common household names. These companies are taking advantage of the huge market for financial planning, investing and asset management among baby boomers.

Also capitalizing on the aging baby boomers are the large health care and pharmaceutical companies. Merck, Bristol-Myers Squibb, Eli Lilly and Pfizer are among the dominant large-caps in this area.

These sectors have propelled large-cap indexes to superb performance in the last five years. The S&P 500, for instance, has returned 21.7 percent over the last five years, versus an annual average of slightly over 11 percent for large-cap stocks since market indexes began to be widely tracked in the late 1920s. Recent large-cap performance has overshadowed that of small-cap stocks, which returned 12.4 percent over the last five years. However, from 1926 through 1995, small-cap stocks outperformed large-cap stocks by 2 percent per year on average (12.5 percent for small-caps vs. 10.5 percent for large-caps), according to a study by Ibbotson Associates.

What's It to You?

Investing in different segments of the market (or asset classes) is the cornerstone of an asset allocation plan and, according to financial experts, it's the single-most important aspect of long-term portfolio performance. Large-cap stocks are an important piece of the asset allocation puzzle for most investors.

Related Reading The Value of Asset Allocation Financial Services Transformed: The New Economy Makeover Why Is the S&P 500 So Hard to Beat?

Although many large-caps will perform differently, often they will more closely resemble each other than they will stocks of smaller companies or other asset classes.

Now that the large-cap waters aren't so murky, you may find that investing is both more interesting and more complicated than you previously thought. For further insight into the world of investing and 401(k) plans, visit mPower's interactive investing "college," Wall Street 101. 

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

Field Guide to Large-cap Stocks

By Tony Custodio
Senior Analyst, mPower

In This Story Joining the Ranks Measuring Performance Large-cap Characteristics What's It to You?

Many areas of the market have seen a reversal of fortune so far in 2000, and large-capitalization stocks and mutual funds are no exception. For five straight years, from 1995 to 1999, the S&P 500 — the oft-cited index representing large-cap equities — returned more than 20 percent per year, gains nearly doubled the historical norm. But, as the end of 2000 nears, with the Index down more than 5 percent, the large-caps look ready to break their winning streak and log negative returns for the year.

Of course, not every asset class can have a good year every year. And, large-cap stocks are still an important part of most investors' asset allocation.

minute: read this article at a glance.

Technical Terms Asset class Market capitalization Standard & Poor's 500 (S&P 500)

First of all, let's define asset classes. They're the categories that your different investments fall into — broad ones include cash, bonds, large-cap stocks, small-cap stocks, and international stocks, though there are a number of more specific permutations. Studies have shown that the key to successful investing is to spread your wealth among different asset classes.

"Cap" refers to a company's market capitalization, or the total number of shares multiplied by the stock's price. This is a gauge of what the market (or investors) believes the entire company to be worth. Generally, companies with a market cap of over $10 billion are classified as large-cap. As of Nov. 13, 2000, General Electric, the largest of large-caps, had a market cap of $510 billion. Market caps change daily, if the stock price changes.

Large-cap stocks are a broad subset of the stock market and they're an important one for retirement savers. According to the Hewitt 401(k) Index, more plan assets are in large-cap stocks than in any other single asset class.

Joining the Ranks

Larger companies tend to have a more established business presence and less uncertainty in sales or profits than smaller (small-cap) companies. Although there are exceptions, larger companies often have slower growth rates and are less risky investments than many smaller companies.

The path to "large-capdom" varies from company to company. As long as the stock price goes up, so does market cap. Historically speaking, stock prices increase as a firm's earnings increase — just how much depends on how much a company can increase its future revenue and earnings or, rather, the market's perception of them.

Juniper Networks, a maker of Internet routers, made its way into large-cap territory very quickly (in less than a year) because investors were willing to bid up the stock based on optimism that its rapidly growing revenue would one day reflect actual earnings. Such a rapid move of stock prices due to investor enthusiasm is an exception, however, and most companies take many years to climb the ranks.

Typically, large-cap companies begin life as small-cap companies. Over many years as public entities, they climb their way up the market-cap ladder as they are able to increase revenue and earnings or, again, the perception of future earnings. Over time, stock prices and market value of companies are driven by earnings growth.

Measuring Performance

Different indexes (or market barometers) are used to represent large-cap stocks — the best known and most widely used is the venerable S&P 500; others include the Russell 1000 and the Wilshire Large Cap 750 Index. Large-cap indexes are rebalanced periodically (usually on a semiannual or annual basis) to reflect the changes in the market values of companies as their stocks increase or decrease in price.

These indexes are often used as benchmarks for mutual funds and pension funds that invest in large-cap stocks. Portfolio managers of large-cap mutual funds usually invest in many of the companies in these indexes; but many also buy stocks outside of the index, or in different proportions, in an attempt to beat the index. Index funds generally include shares of all the companies in the underlying index in an attempt to exactly match its returns.

Large-cap Characteristics

Most large-cap stocks are in the technology, financial services and health care sectors, which makes sense given that these sectors play an ever-increasing role in the economy.

Large-cap technology stocks, such as Intel, Microsoft, IBM, Cisco Systems and Oracle, are among the biggest players in the U.S. and in the world as technology continues to be vital in homes and businesses.

Financial services, also a large sector of the economy, has done very well in recent years in the low-interest-rate and bull-market economic environment. Many large-cap financial stocks, such as Morgan Stanley Dean Witter, American Express and Citigroup, are common household names. These companies are taking advantage of the huge market for financial planning, investing and asset management among baby boomers.

Also capitalizing on the aging baby boomers are the large health care and pharmaceutical companies. Merck, Bristol-Myers Squibb, Eli Lilly and Pfizer are among the dominant large-caps in this area.

These sectors have propelled large-cap indexes to superb performance in the last five years. The S&P 500, for instance, has returned 21.7 percent over the last five years, versus an annual average of slightly over 11 percent for large-cap stocks since market indexes began to be widely tracked in the late 1920s. Recent large-cap performance has overshadowed that of small-cap stocks, which returned 12.4 percent over the last five years. However, from 1926 through 1995, small-cap stocks outperformed large-cap stocks by 2 percent per year on average (12.5 percent for small-caps vs. 10.5 percent for large-caps), according to a study by Ibbotson Associates.

What's It to You?

Investing in different segments of the market (or asset classes) is the cornerstone of an asset allocation plan and, according to financial experts, it's the single-most important aspect of long-term portfolio performance. Large-cap stocks are an important piece of the asset allocation puzzle for most investors.

Related Reading The Value of Asset Allocation Financial Services Transformed: The New Economy Makeover Why Is the S&P 500 So Hard to Beat?

Although many large-caps will perform differently, often they will more closely resemble each other than they will stocks of smaller companies or other asset classes.

Now that the large-cap waters aren't so murky, you may find that investing is both more interesting and more complicated than you previously thought. For further insight into the world of investing and 401(k) plans, visit mPower's interactive investing "college," Wall Street 101. 

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.