By Dr. David Eifrig, editor, Retirement Millionaire
Where do you get your edge?
The “efficient market” hypothesis tells us that stock prices reflect all available information at any point in time… But we all know that’s not always the case.
You can earn bigger returns. Otherwise, the best anyone could ever do is track the market.
Oftentimes, the eye-popping returns come from small growth stocks. Those are the ones with more room to grow, and Wall Street doesn’t watch them as closely. That’s why speculators have long loved to dabble in small-cap stocks.
But today, we’re seeing something different…
We’re not seeing the biggest returns in the smaller stocks. Rather, the stocks that are making the biggest gains are the ones most investors are eyeing.
This means it’s a good idea to keep focusing on big, household names. And as I’ll show you, these companies have a major advantage in a crisis… thanks to cold, hard cash.
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Stocks with market capitalizations of more than $200 billion, known as “mega-caps,” have been generating the biggest returns in recent months and years.
As you can see, mega-cap stocks have done much better than small-cap stocks over the past year. They were outperforming before the COVID-19 crisis. And it’s still true today…
Currently, 25 stocks in the S&P 500 Index have market caps exceeding $200 billion. And all of them are household names… including Amazon (AMZN), Facebook (FB), JPMorgan Chase (JPM), and Verizon (VZ).
Out of the 25 mega-caps, two of the top three biggest winners over the last 12 months are both worth more than $1 trillion… Apple (AAPL) and Microsoft (MSFT). Nvidia (NVDA), which has a $230 billion market cap, has been the biggest winner with a gain of about 150%.
The question you should be asking is: How could Apple and Microsoft, the two biggest companies in the U.S., each gain more than 50% over the past year?
These are two of the most heavily scrutinized companies in the U.S. stock market. You can’t flip on CNN without hearing about either of them. Yet they’re not acting like massive, mature stocks.
Some will point to the rise of passive investing as a reason for this incredible gain… and that may be a factor. After all, when people pump money into mutual funds that track big, weighted stock indexes, like the S&P 500, more money flows into the bigger names.
But I think the main reason is more obvious…
Investors are risk-averse and don’t want to take chances on uncertain businesses.
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In the wake of the COVID-19 crash, investors are still wary about most stocks. No one who remembers the financial crisis of 2008 wants to get burned in another one.
So many are too afraid to stray away from proven businesses with economic moats. And you don’t get to be a mega-cap without a proven business model.
It’s important to know one more thing… Mega-cap stocks also bring in loads of cash. And as a shareholder, piles of cash help you sleep at night. Cash helps a company handle market downturns better than others.
Longtime readers know we like to look at a company’s free cash flow (“FCF”) as an indicator of its financial strength…
That’s the cash a company generates from its operations minus capital expenditures. It’s the amount available for management to buy back stock, issue dividends, and make acquisitions.
For us as shareholders, we want companies that generate lots of cash on less revenue. We measure that by looking at FCF margin – or FCF divided by sales.
Mega-caps, by far, have higher FCF margins than the rest of the S&P 500 and small caps…
In other words, for every dollar of sales, mega-cap stocks are left with about $0.18 of FCF available for shareholders. We consider a company with an FCF margin of 10% to be healthy.
Investors pay a premium valuation for that profitability. Mega-caps have an average price-to-earnings (P/E) ratio of 29, while the broader S&P 500 Index trades for around 22 times earnings.
Still, investors don’t mind paying up, given mega-caps’ safety. Share prices will fluctuate, but investors know that these giants won’t go belly-up anytime soon.
And as always, buying begets buying. The more investors gravitate to mega-caps, the more prices rise, which leads to more folks buying them. This is called “herd mentality.” People see their friends making money on Apple and Microsoft, so they want in on the action.
We expect the momentum will feed itself. Money will continue to flow into these big stocks… The winners will keep winning.
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Recently, Doc has highlighted the risks of investing in small companies right now… the phenomenon of COVID-19 “superspreaders”… and one investment that he believes will compound your long-term wealth, even through the pandemic. You can read all these stories and more in his free Health & Wealth Bulletin. If you’re ready for daily insights about how to protect your wealth – and health – this year, go here to check it out.