3 Large-Cap Stocks That Will Beef Up Your Portfolio
I love small- and mid-cap stocks for their potential return, but large-cap stocks are still the biggest portion of my portfolio.
Small-cap companies promise the highest returns but have the highest amount of risk. Mid-cap companies have grown out of some of that risk but can still offer decent returns.
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Why even hold large-cap stocks? Why not just fill my portfolio with small- and mid-cap companies with potential and hold on for the ride?
There’s a lot to be said for shares of the world’s largest companies. It’s easy, after nearly a decade of bull market returns, to forget the need for safety and financial flexibility in a crisis. Both small- and mid-cap indexes underperformed their larger peers from mid-2007 through the worst of the Great Recession.
#-ad_banner-#And that relative safety doesn’t mean large-cap stocks can’t provide outsized returns. Trillion-dollar heavyweight Amazon has seen its share price double over the last year.
Beyond this, I’ve got three reasons why large-cap stocks need to be a part of every portfolio and three best-of-breed picks in their niche.
Why Large-Cap Stocks Rule The Market
While they may not have the growth of a runaway small-cap, companies with a market cap larger than $10 billion can take advantage of their financial might.
Large-cap companies have all the liquidity they need through credit lines and bonds, taking advantage of low interest rates for financial leverage. While the business model may not be as flexible, these giant companies can acquire growth in any corner of the global market.
After nearly a decade of bull market gains, the bear market prognosticators are getting pretty tired. But that doesn’t mean the cycle won’t end eventually. Blooming inflation and tight labor conditions could push wages higher and profits lower, sparking a recession that could crush valuations in overbought small-caps. The largest companies have the financial flexibility and the cash cushion to withstand even the worst economic conditions.
These more established and mature businesses also usually mean a cash machine for investors with the S&P 500 paying a 1.7% yield versus 1.5% on the small-cap and mid-cap indexes. That liquidity in large cap stocks is also evident in their share buyback programs, adding more cash yield for investors.
How To Find Large-Cap Stocks For Your Portfolio
Large-cap stocks are generally any company with over $10 billion in share value with the newer mega-cap designation for companies of $200 billion or more. While I don’t think you need to limit your large-cap portfolio too much, I like looking for companies with a capitalization of $50 billion or more.
This narrows the list a little to those truly international powerhouses but still leaves nearly 350 firms to filter further.
Revenue growth has been sluggish over the last few years and even the largest companies have had trouble passing costs on to customers. I like to filter my large-cap picks to those making at least the S&P average for year-over-year revenue growth. As of the third quarter 2018, that’s about 9%, according to research by CSI Market.
I also look for a solid balance sheet with a cash reserve that can be used to cushion any short-term needs and cash return through either the buyback or dividend policy. Finally, I look for companies with a sustainable competitive advantage in their industry and potential catalysts for growth.
Microsoft Corporation (Nasdaq: MSFT) is no longer reliant on Windows and Office as it once was but has built an $886 billion conglomerate in cloud, social media, and consumer electronics. The company has a firm hold on the #2 position in cloud services and uses this to maintain its leadership in productivity even as the company shifts to the cloud.
Microsoft has one of the strongest balance sheets in large-cap tech with over $134 billion in cash against just $72 billion in long-term debt. The company generates over $30 billion in free cash flow annually and pays a 1.6% dividend yield. The repurchase program has returned an additional $10 billion to investors for almost a 3% cash yield.
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Shares trade relatively expensively at 30 times trailing but earnings are expected to grow 10% over the next year and the combination of network effects and cost advantages in its complementary product lines gives Microsoft a strong competitive moat.
Chevron Corporation (NYSE: CVX) is a great way to get diversified exposure to the entire oil & gas supply chain with a $238 billion powerhouse market capitalization. The company has built a leading position in the Permian basin and new production from LNG projects Gorgon and Wheatstone could significantly increase revenue.
Chevron is in the later-stage of its current project investment cycle which means capital spending could plateau or even fall as production increases. Combine this with high energy prices and earnings could beat even the 67% growth expected by analysts over the next four quarters.
Revenue growth jumped by 22% last year while gross profits grew at an even faster 26% rate through 2017. Shares pay a solid 3.7% cash yield and are still below the 2014 peak.
Celgene (Nasdaq: CELG) demonstrates the power of a $63 billion market cap with surprisingly steady earnings growth for a biotech company. Compared to smaller peers, Celgene can spend aggressively or acquire pipeline development and has beaten earnings expectations in 14 of the last 15 quarters.
Myeloma treatment Revlimid has produced blockbuster growth recently with sales of nearly $2.5 billion in the second quarter alone and the potential to extend its patent duration through current studies. Morningstar expects sales to grow to as much as $22 billion by 2021 and several late-stage pipeline drugs like fedratinib and ozanimod could reach blockbuster status.
The company doesn’t pay a dividend but returned more than $3.8 billion to investors, approximately 6% of market capitalization, through the buyback program. Shares trade for just 11 times trailing earnings which are expected 18% higher over the next four quarters.
Risks To Consider: Big doesn’t always mean better so look for best of breeds with competitive advantages as well as economies of scale.
Action To Take: Balance your portfolio with relative safety in large cap companies for potential growth and the financial flexibility to withstand an eventual recession.