What it means
Investors often sort stocks using two labels. Size refers to market capitalisation (the total value of all a company's shares), with large companies usually meaning those in the upper tier of a stock market.
Style refers to whether a stock is considered growth or value. A value stock trades at a low price relative to measures such as earnings, book value (the accounting value of the company's net assets) or dividends.
Common signals include a low price-to-earnings ratio, a low price-to-book ratio and a high dividend yield. A large value stock combines these features with the size and stability of a major company.
These companies often come from mature industries such as banking, energy, consumer staples and industrials. They tend to have long track records, steady cash flow and dividends.
Their share prices may grow more slowly than those of fast-growing companies, but they may also fall less in a downturn. A large value stock is not automatically a bargain.
A low price may reflect real problems, such as declining sales, heavy debt or a business model under threat, a situation sometimes called a value trap. Analysts therefore look beyond the ratios to the quality of the business and its prospects.
Index providers and fund managers publish large value indices, and funds track them. Investors may choose them to balance portfolios that hold many growth stocks.
Because definitions differ between providers, it helps to know which rules a fund uses. Fund labels deserve some care, because the same company can be called large value by one provider and large blend by another.
Index providers use different ratios, weights and cut-off points, and they review their lists regularly. Before buying a fund, read its factsheet to see which measures it uses and which companies sit at the top of the portfolio.
In practice
Real-world examples.
Example
A pension fund holds a basket of large value stocks to generate dividend income for retirees. The fund manager accepts slower growth in exchange for steady payments. Dividend growth is monitored every year to make sure the payouts remain sustainable.
Example
An individual investor compares two energy companies of similar size. She chooses the one with a lower P/E and higher dividend yield, after checking that its debt is under control. She also compares the cash flow of each company over several years.
Example
A portfolio built mainly of technology growth shares adds a large value fund to reduce volatility. The adviser explains that the two styles often perform differently over time. The mix is rebalanced once a year to keep the intended proportions.
Formula
Calculation
Price-to-earnings (P/E) ratio = share price / earnings per share
Dividend yield (%) = annual dividend per share / share price x 100
Market capitalisation = share price x number of shares
Worked example: a company has a share price of $60, earnings per share of $5, an annual dividend of $2.40 per share and 500 million shares in issue.
Step 1: P/E = 60 / 5 = 12.
Step 2: Dividend yield = 2.40 / 60 = 0.04, then 0.04 x 100 = 4%.
Step 3: Market capitalisation = 60 x 500 million = $30 billion.
A P/E of 12 and a 4% yield are typical of the value style, and a $30 billion market capitalisation puts the company firmly in the large category.Case study
Seen in the real world.
Stonebridge Bank is a fictional lender with a market value of $25 billion, a P/E of 9 and a dividend yield of 5%. Investors saw it as a classic large value stock, but its share price had been flat for years.
An analyst noticed that bad loans were rising in one region and that the bank had been cutting its provisions to protect profit. She concluded that the low P/E reflected genuine risk, not a bargain.
In this illustrative story, the analyst avoided the stock, and the bank later cut its dividend after loan losses rose. The case shows why a low ratio is only a starting point for analysis. The analyst later wrote a checklist that compares debt, cash flow and dividend cover before any purchase.
Watch out
Common mistakes.
- Assuming a low P/E means a stock is cheap, when the market may be pricing in real problems.
- Treating all large value stocks as safe, when even big companies can suffer losses and cut dividends.
- Ignoring that fund providers define value and large differently, which changes what a fund actually holds.
Questions
People also ask.
What makes a stock a value stock?
It trades at a low price compared with earnings, assets or dividends, suggesting the market may be underestimating it.
How is a large value stock different from a small value stock?
The company is bigger, usually more stable and easier to trade, but may have less room to grow quickly.
Do large value stocks pay dividends?
Many do, though payments are not guaranteed and can be reduced if profits fall.
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