Most individual investors don't have an unlimited amount of time and energy to research the latest and greatest growth stocks. Instead, they stick to what they know. People who shop at Wal-Mart gravitate to its stock. Techies prefer the likes of Apple and 3D Systems, and motorheads often favor General Motors and Ford.
What do companies like these have in common? They're huge, widely known, and seemingly ubiquitous. To use the vernacular of Wall Street, they serve as textbook examples of mega-cap stocks.
What are mega-cap stocks?
There is no set definition for mega-cap stocks. Some define the group as companies with market capitalizations exceeding either $50 billion or $100 billion. Others say the designation refers to companies with market caps in excess of $200 billion. And still others claim they are merely the 100 largest companies on the S&P 500.
But regardless of how you define them, these are the biggest and, in many cases, best companies in the investing universe. As Investopedia notes, they are usually "household names with strong brand recognition and global operations."
Foremost among these is Apple, the innovative company behind the iPhone, the iPad, and iTunes. In the summer of 2011, the Cupertino-based company surpassed ExxonMobil to become the largest company in the world by market cap. And while the two have since traded places more than once, they are the prototypical examples of mega-cap stocks, with valuations well in excess of $400 billion each.
How many mega-cap stocks are there?
The size of the mega-cap universe depends on how you define the term. If the threshold is $50 billion, then roughly 90 American companies make the cut. Raising it to $100 billion reduces the number to between 30 and 40. And if you take it all the way up to $200 billion, then you're left with about a dozen.
It's important to note, moreover, that because a company's market cap changes with its stock price, companies can fall in and out of mega-cap status. Bank of America is a prime example. Prior to the financial crisis, the North Carolina-based bank was valued in excess of $200 billion. But by 2009, it had dropped to less than $25 billion as panicked investors rushed to sell shares in fear of nationalization or failure. Fast-forward another five years, and the bank's market cap has recovered to more than $150 billion.
Furthermore, while mega-cap stocks have traditionally been based in the United States, Europe, and Japan, this geopolitical divide no longer holds true. China in particular is now home to a handful of companies with market caps in excess of $100 billion. Leading the way is PetroChina, the country's biggest oil-producer. Following closely behind are three massive and growing financial institutions: Industrial & Commercial Bank of China, China Construction Bank, and Agricultural Bank of China.
What drives mega-cap stocks?
There is nothing secret or particularly unique about the forces that drive mega-cap stocks relative to, say, their large- or mid-cap counterparts. On a general level, all companies are affected by the health of the underlying economy. Because the U.S. is the largest in this respect, it often exerts the biggest impact. Due to their global presences, however, mega-cap stocks are also vulnerable to the economic ebbs of flows of other countries and regions.
More specifically, two economic forces in particular can either weigh on or boost the performance of mega-cap stocks and the companies underlying them. The first is unemployment. In short, if people aren't employed, they have less money to spend, and therefore the economy will contract. The second, related factor is consumer and investor confidence.
Beyond these there are sector-specific factors. For instance, while Exxon and Bank of America both benefit from low unemployment, the former's profit is more directly tied to oil prices, while the latter's profit depends significantly on the relationship between short-term and long-term interest rates. And along the same lines, people won't buy Apple's wares unless its products are somehow superior to the competition's.
What's the advantage of mega-cap stocks?
From an investment perspective, there are multiple advantages associated with buying and owning mega-cap stocks.
First, the underlying companies are tried and true. They're relatively safe compared to small start-up companies with unproven products or services. Put another way, mega-cap companies have economic moats that help to insulate them from competition. Consumers buy Tide laundry detergent because they trust it. The same is true of Gillette razors. It's for this reason that Procter & Gamble is often considered to be a textbook mega-cap stock.
Additionally, mega-cap stocks have a tendency to distribute more of their income to shareholders via dividends. This makes the category particularly attractive to retirees and other types of income-seeking investors. You can see this by looking at the 10 biggest companies in America. Taken together, they have a median dividend payout ratio of 37%, meaning that they distribute more than a third of their earnings every year to shareholders.
The bottom line on mega-cap stocks
Ultimately, an investor's choice of stocks is based on individual preference. That being said, mega-cap stocks are well-suited to serve as the backbone of anyone's long-term stock portfolio thanks to their relative stability and flair for both generating and distributing earnings.
Try any of our Foolish newsletter services free for 30 days. 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.