The Continuing Case For Mega Caps (OEF, IOO, DVY, IDV, HDV)

Russ Koesterich: Last year, mega-cap companies were cheaper and more profitable than their smaller counterparts. That’s why I continuously advocated for mega-cap, quality stocks as a defensive play amid last year’s market volatility, economic shocks and political paralysis. Ultimately, investing in mega caps in 2011 was a good call.

Now, after last year’s flight to safety, many investors are asking if mega-cap stocks are still a bargain. As I write in my recent Market Update piece, the answer is a resounding yes.

Despite outperforming in 2011, mega caps are still trading at a historically high discount to other segments of the market. Let’s take US mega caps, for example. At the end of 2011, the S&P 100 Index traded at 12x trailing earnings, while the broader Russell 3000 Index traded at 14x.

This represents a discount of approximately 15% for mega caps and compares favorably with a long-term average discount for the stocks of around 9%. The chart below nicely shows how the relative valuation of US mega caps has generally been declining over the last decade.

Source: Bloomberg, 12/31/2011.

The situation looks even more favorable for global mega caps. They currently trade at 11x earnings. In comparison, the MSCI World Index currently trades at 13x earnings.

Large stocks in most defensive sectors also still appear to be a bargain. The one exception: US utilities. Of the four classic defensive sectors – utilities, consumer staples, healthcare and telecommunications – only utility stocks are trading above their long-term average valuations.

Given the prospect for more volatility and politically-driven risk this year, I expect large, dividend paying stocks to continue to outperform. In short, there is a compelling argument for sticking with the mega-cap trade in 2012 [potential iShares solutions: iShares S&P 100 Index Fund (NYSE:OEF), iShares S&P Global 100 Index Fund (NYSE:IOO), iShares Dow Jones Select Divide (NYSE:DVY), iShares Dow Jones EPAC Select Dividend (NYSE:IDV), iShares High Dividend Equity Fund (NYSE:HDV)].

Source: Bloomberg

Written By Russ Koesterich From The iShares Blog Disclosure: Author is long IOO and DVY.

Russ  Koesterich, CFA, is the iShares Global Chief Investment  Strategist as  well as the Global Head of Investment Strategy for  BlackRock Scientific  Active Equities. Russ initially joined the firm  (originally Barclays  Global Investors) in 2005 as a Senior Portfolio  Manager in the US  Market Neutral Group. Prior to joining BGI, Russ  managed several  research groups focused on quantitative and top down  strategy. Russ  began his career at Instinet in New York, where he  occupied several  positions in research, including Director of Investment  Strategy for  both US and European research. In addition, Russ served as  Chief North  American Strategist for State Street Bank in Boston.

Russ holds a JD from Boston College Law School, an MBA from Columbia  Business School, and is a holder of the CFA designation. He is also a  frequent  contributor to the Wall Street Journal, New York Times,  Associated  Press, as well as CNBC and Bloomberg Television. In 2008,  Russ published  “The ETF Strategist”(Portfolio Books) focusing on using exchange traded  funds to manage risk and return within a portfolio.

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