Microcap stocks are a category of stocks consisting of small companies. These stocks have a low market capitalization, particularly in comparison to the larger stocks traded in major stock markets. Market capitalization equals a stock’s share price multiplied by the total number of outstanding shares of the stock.
Microcap stocks typically are too small in value to qualify to trade on a stock exchange. Instead, most microcap stocks are traded over the counter. Over-the-counter stocks are traded directly between brokers and dealers. Microcap stocks are not often the focus of concentrated market interest, according to the Securities and Exchange Commission. Instead, a small number of their shares are traded at any one time. In addition, microcap stock prices tend to be low because of the low demand for them.
Stocks that trade on an exchange such as the New York Stock Exchange -- or NYSE Euronext -- must meet strict listing standards designed to protect investors. These standards include governance guidelines and a minimum level of assets. Microcap stocks do not have to meet these listing standards. In addition, the relative anonymity of microcap stocks means that investment researchers less frequently study and file reports about them than their larger counterparts. Research reports are a valuable tool for investors in larger stocks.
Although microcap stocks do not have listing standards, some of them must file reports with the SEC, providing the public with an access point to acquiring information about this class of public company. Required information includes details of the stock’s financial condition. Microcap stocks with more than 500 investors or $10 million or more in assets must file with the SEC. So must over-the-counter stocks that post their price quotes on the OTC Bulletin Board.
Risk and Reward
Microcap stocks are considered risky investments for several reasons. They often are new companies with no established history of success. Their products or services may be in the infant stage, making it particularly difficult to gauge the likelihood of success. Also, the relative scarcity of public information increases the risk of corporate fraud, according to the SEC. The trade-off with microcap risk is that the rewards are potentially high if the company succeeds. Because microcap stock prices are low and the companies are small, tremendous room exists for growth and robust returns.