The terms microcap stock, small cap stock and penny stock are sometimes used interchangeably but key distinctions exist. Microcap and small cap stock deal with the total capitalization of a company, while the term penny stock deals with the price of a stock. Although no hard guidelines exist for determining microcap, small cap and penny stock, investors should understand basic information regarding the terms to help determine the risk of a stock.
Understanding Microcap Stock
According to the United States Securities and Exchange Commission, microcap stocks describe public companies with low total capitalization, which equals the total market price of a stock times the number of outstanding shares. Investors interested in microcap stocks can make trades on over-the-counter markets, such as the Over-the-Counter Bulletin Board and the Pink Sheets. The SEC states that companies issuing microcap stocks typically possess an average of $6 million dollars in net assets, with many companies owning less than $1.25 million in assets.
Understanding Small Cap Stock
Similar to a microcap stock, the guidelines to distinguish a small cap stock are ambiguous. According to AXA Equitable, many investors use the SmallCap 600 Index as a benchmark to determine if a stock is considered small cap. The index includes companies with total capitalization of less than $1 billion dollars. Companies that issue small cap stocks typically focus on delivering products and services that serve a niche market or emerging industries where demand is expected to grow substantially.
Understanding Penny Stock
Investors typically classify penny stocks as generally under $5 dollars a share. Small start-up companies with unstable financial histories typically issue penny stocks, making the stock speculative in nature. The SEC places certain restrictions on trading penny stocks. Investment brokers must obtain written agreement from investors before selling penny stocks to a customer. Investment firms must also provide an investor with documentation fully describing the risks of trading penny stocks.
Why are the Differences Important
Investors should understand the differences between microcap, small cap and penny stocks to estimate the possible return on their investment and volatility associated with the stock. Depending on the type of stock, investors may find it difficult to obtain financial information. Unlike small cap stock, no index exists to use as a benchmark for microcap and penny stock. The primary benefit of the three stock classifications is the possibility of earning a high return on investment because small companies can grow rapidly. A disadvantage is that small companies typically do not pay dividends and investors may find it difficult to sell shares because of low trading volume.