Prevent Large Caps From Killing Your Returns

My title might be a dead giveaway. But I'll ask regardless.

What do AT&T (NYSE: T  ) , Wells Fargo (NYSE: WFC  ) , and Merck (NYSE: MRK  ) have in common?

Investors in any should quickly know the answer.

They know these are large-cap companies with strongly growing sales. Yet, they're also well aware that these companies' stocks have been lackluster performers over the past five years.

Here are the specifics:

Company

5-Year Annual Growth Rate of Sales

5-Year Annual Stock Return

AT&T 20.5% 7.8%
Merck 15.9% 5.4%
Wells Fargo 18.0% (1.7%)

Source: Capital IQ, a division of Standard & Poor's.

It's remarkable when you think about it. With the phenomenal success of the iPhone (AT&T), an acquisition of Wachovia (Wells Fargo), and an acquisition of Schering-Plough (Merck), you'd think these companies' stocks would have proven to be more successful.

Yet their returns to shareholders over the past five years have been pretty modest!

It's a pretty common problem
In fact, these aren't the only large-cap companies that fit this bill over the past half-decade.

Technology large caps eBay (Nasdaq: EBAY  ) and Cisco (Nasdaq: CSCO  ) have also grown sales (at a compounded annual growth rate of 14.1% and 9.6%, respectively, over the past five years), yet their stocks lost investors money over the same time period.

This might make you question whether you should own large caps altogether. But I don't think that's necessarily the right answer.

First off, the problem is not one that affects large caps alone. Many small caps -- notably Wendy's/Arby's Group and JetBlue also fall into the same category.

But you'd think large caps would have been better performers over the past five years. After all, during periods of economic difficulty, investors are often willing to pay a premium for them because they're global forces that even faster-growing small-cap companies can't easily compete with -- meaning that owning them also provides stability and geographical diversification during periods of economic difficulty.

Plus, many large caps pay dividends that you can use either to lower your cost basis (if you reinvest them) or to invest in other companies.

But there's another strategy you might not be familiar with could help you eke out additional returns from stagnant large cap positions like those I shared above.

How to juice your large-cap returns
Investors can easily gain some additional income from large caps by trading options.

The most conservative way is to sell covered calls on large-cap positions you own that might decline or stagnate in the near future.

Say a large-cap stock you own is trading around $55, and you'd be happy to sell it at $60. You could sell calls against this position, collecting cash each time you write them.

As long as the stock doesn't reach or cross the $60 mark, you'll pocket these premiums and can repeat the process, adding to your final gains on this large cap.

The second way is to write puts on large caps that you would like to buy or buy more of at a lower price.

Say a stock you're interested in is trading around $40 per share, and you'd love to buy it at $30 per share. You could write $30 put options, from which you'd collect a premium.

If the stock falls below $30 before the expiration date, you will buy the share at your desired price. But if the stock stays above $30 per share, you keep this premium and can repeat the process as long as you'd like.

One of just many simple options trades
Of course, these are just two of the most basic options trades you can make to profit from large-cap positions that you already own or that you'd like to own.

If you'd like to learn more about these strategies -- or you'd like to know the details of more advanced options strategies you can employ on large cap stocks, I invite you to check out the strategies of our Motley Fool options experts Jeff Fischer and Jim Gillies.

For a limited time, they're sharing their options trading guide and a video series completely free. Some investors have paid nearly $1,000 to get access to their options strategies, but it can be yours free today. And it's meant for beginners and experts alike. Simply drop your email address in the box below for more information. 

Adam J. Wiederman owns no shares of the companies mentioned above. The Motley Fool owns shares of Wells Fargo. The Fool has created a bull call spread position on Cisco Systems. Motley Fool newsletter services have recommended buying shares of AT&T, eBay, and Cisco Systems. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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