Large market capitalisation companies are historically a source of stability for investors because their scale and established reputation with consumers serve as a buffer for revenue-making operations when economic quakes occur.
In general, the stock prices of such businesses may not grow as fast as smaller companies because they are already leaders in their respective markets. However, what they lack in growth opportunity they make up for in the potential for stable and sustainable dividend payments.
Despite the well publicised plight of Pearson, which earlier this year announced its intention to cut its dividend payout after issuing the latest in a string of profit warnings, dividends paid by large companies are more secure than those paid by small and medium sized companies, broadly speaking.
Many investors have turned to dividend stocks to supplement lowly bond yields amid a period of significant quantitative easing by central banks.
Another carrot when it comes to investing in large caps is the glut of information that allows investors to make well-informed decisions about these companies.
The FTSE 100 is trading at record highs at present, but the UK investment landscape has ventured into uncharted territory following the Brexit referendum vote on 23 June last year – which is set to challenge the notion of stability with large caps.
Mark Dampier, head of research at Hargreaves Lansdown, said: “I do not think anyone knows the impact Brexit will have on large caps. One would assume that big UK companies have enough clout to withstand the challenges.”
Article 50 has now been triggered and Brexit talks are due to start shortly after the election, but the prospect of Brexit has resulted in a 13 per cent slump in sterling to £1 being worth $1.28 in 11 months to May.
Adrian Lowcock, investment director at Architas, said firms around the world are seeking to cash in on opportunities presented by the fall in sterling.
He added: “Sterling has probably bottomed unless we see major disruptions from the Brexit negotiations. Of course, by the same token, it is more expensive for UK companies to engage in merger and acquisition activities abroad.”
FTSE 100 listed Unilever, for example, was earlier this year subject to a colossal £115bn takeover bid from US food juggernaut Kraft Heinz – owner of widely popular Heinz Tomato Ketchup.
The bid was abandoned after a vehement rejection from Unilever, which later unveiled plans for a comprehensive review of its business to boost returns for shareholders.
Mr Dampier said: “I’m surprised that Kraft called off the takeover bid as quickly as it did. I think this is a sign of things to come. Large caps are struggling to grow their business because of things like stiffer regulation, a general slowdown in growth of global markets and the issues that come with an ageing population. These companies are seeking growth – albeit through inorganic means.
“Currency is not the sole factor behind a takeover approach, but the devaluation of sterling has probably encouraged foreign companies to accelerate their merger or acquisition plans with UK companies.”
Cheap credit, which is largely a result of central banks’ quantitative easing programmes, is likely to result in the proliferation of debt-financed mergers and acquisitions, according to Mr Lowcock.
He said: “Cheap debt has been around for a while. What is more important is for a company to be confident in its future direction and to utilise cheap debt. You do not want to see debt spiral out of control though. The more debt a company takes on, the less flexibility it enjoys when it comes to expenditure.”
Stockholders of multinational businesses listed on the FTSE 100 that pay out dividends in US dollars benefited from a bumper pay out because of a fall in sterling.
On the other hand, Morningstar estimates that between 25 per cent and 30 per cent of large-cap revenue is derived onshore, meaning a rally in sterling would be detrimental to the index.
Dean Aitchison, investment manager at Stansted-based KMD Private Wealth Management, said: “The pressing questions are: how high will the Fed raise rates and how fast?
"Many companies have utilised cheap debt, but the cost of debt looks set to rise, which is set to eat into these companies’ earning unless the debt is offloaded.
“Markets have priced in two rate raises in 2017 so there may be support for share prices if they fail to materialise.”
There is also a sentiment among some observers that that biggest UK blue chips are overvalued. Mr Aitchison said: “The higher valuation of UK large caps is partly justified by the increased earnings through currency gains. They have also been propped up by low interest rates and a fall in commodity prices – particularly oil prices.
“Valuations are higher, but they are not on the same level as they were during the ‘Dotcom’ period.”
Figures revealed by the Office for National Statistics revealed inflation rose to 2.7 per cent in April from 1.6 per cent in December – resulting from the weaker pound, which has increased fuel and import costs.
Mr Aitchison said: “Analysts thought the advent of Brexit and Trump’s presidency would be detrimental to markets, but they have instead elevated their growth because large companies have focussed on the fundamentals. The ‘Trump effect’ on large cap all hinges on whether he delivers on his spending package.”
Question marks have also been raised on the stability of dividends offered by the biggest blue chips in the UK. An AJ Bell report, published in mid-December, found that the dividend cover for the FTSE 100 index stood at a lowly figure of 1.46 times earnings.
The ideal cover should be two times earnings because it means only half of a company's profits are being used to pay shareholders.
Mr Lowcock said: “Large cap companies still need to grow because many are dividend payers and are therefore under pressure to meet their obligations to shareholders.
“UK companies tend to grow because of the sheer scale of their businesses, but there is a lack of technological disruptors for firms in the UK market whereas the US market is replete with the likes of Google, Apple and Amazon. The latest innovations produced by such companies have generated impressive growth.”
Myron Jobson is a former features writer of Financial Adviser
