Microcap Stocks: Definition, Characteristics & Investment Potential

The term “microcap,” also known as micro-cap, is generally used for companies with a low market capitalization, usually ranging between $50 million and $300 million. Market capitalization is the product of a company’s share price and its outstanding sharesOutstanding SharesOutstanding shares represent the number of a company’s shares that are traded on the secondary market and, therefore, available to investors. Outstanding shares include all restricted shares held by the company’s officers and insiders (senior employees), as well as the equity portion owned by institutional investors, and it changes daily.

Microcap stocks can either be newly listed companies with very few regulations or smaller companies with significant potential to become large-cap stocks in the future. While the categorization of stocks by market capitalization can vary between different market participants, stocks are usually classified as per the below categories:

Summary

• Microcap is a general term used to define stocks with a market capitalization of between $50 million and $300 million.
• Microcap stocks are usually traded over-the-counter, with ave low publicly available information, and are riskier to invest in than large-cap stocks.
• Investors must be cautious while investing in microcap stocks and must only invest after conducting thorough due diligence on the stock they want to invest in.

Table of Classification according to Market Capitalization

ClassificationMarket Capitalization RangeLarge-capGreater than $10 billionMid-cap$2 billion to $10 billionSmall-cap$300 million to $2 billionMicro-cap$50 million to $300 millionNano-capLess than $50 million

Features of Microcap Stocks

1. Lack of public information

The biggest difference between microcap stocks and stocks with higher market capitalization is the accuracy of the publicly available information about the company. Most large public companies file their reports with the national regulatorSecurities and Exchange Commission (SEC)The US Securities and Exchange Commission, or SEC, is an independent agency of the US federal government that is responsible for implementing federal securities laws and proposing securities rules. It is also in charge of maintaining the securities industry and stock and options exchanges, which can be easily accessed on the regulator’s website by any investor. Also, large-cap stocks are regularly researched on and written about by equity analysts, and their stock price is easily available on the internet.

However, similar information is seldom easily found publicly for microcap stocks. Many of the microcap companies do not file their reports with their respective regulator, making it difficult for investors to get relevant information.

2. High risk

Investing in stocks, in general, involves a certain amount of risk. However, microcap stocks come with a higher risk than large-cap stocks. Many of the microcap companies are new and do not have any historical information. Some may not have any significant revenues either because their products are in development or not yet launched in the market.

They are characterized by low trading volumes, which makes it difficult for an investor to sell his/her investment when he/she wants to do so. Due to low trading volumes, any large sell-off directly will significantly impact the stock price. The companies are also prone to fraud and corporate governanceCorporate GovernanceCorporate governance is something altogether different from the daily operational management activities enacted by a company’s executives. It is a system of issues.

3. No minimum listing standards

Every company that intends to list its stock on the exchange must meet the minimum listing standards set by the exchange. The requirements can range from holding a certain minimum value of assets to a minimum number of shareholders.

Microcap stocks do not need to meet such listing requirements. However, at times, companies whose securities are quoted in the OTC market may need to meet the minimum criteria imposed by the trading system.

4. Traded over the counter

Microcap stocks lack the liquidity and listing requirements of large-cap stocks; hence many are traded in the over-the-counter (OTC)Over-the-Counter (OTC)Over-the-counter (OTC) is the trading of securities between two counter-parties executed outside of formal exchanges and without the supervision of an exchange regulator. OTC trading is done in over-the-counter markets (a decentralized place with no physical location), through dealer networks. market. Over-the-counter means that the stocks are not traded on the exchange but rather are directly traded between the broker and the dealer or on OTC systems.

5. Potentially high rewards

The trade-off with investing in microcaps is that with the higher risk, there is a possibility of higher rewards if the company becomes a multi-bagger. Finding such multi-baggers requires a thorough due diligence process by the investor. Almost every large-cap stock today began its journey as a small company.

An investor must understand the company’s financials, its business strategy, and future potential, and only then decide to invest in the company. Once the due diligence is completed, an investor must be patient with the investment, as the share price of smaller companies is highly volatile and sensitive to market sentiments.

Additional Resources

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• Rate of ReturnRate of ReturnThe Rate of Return (ROR) is the gain or loss of an investment over a period of time copmared to the initial cost of the investment expressed as a percentage. This guide teaches the most common formulas
• Types of SEC FilingsTypes of SEC FilingsThe US SEC makes it mandatory for publicly traded companies to submit different types of SEC filings, forms include 10-K, 10-Q, S-1, S-4, see examples. If you are a serious investor or finance professional, knowing and being able to interpret the various types of SEC filings will help you in making informed investment decisions.
• Valuation MethodsValuation MethodsWhen valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent transactions
• Volume of TradeVolume of TradeVolume of trade, also known as trading volume, refers to the quantity of shares or contracts that belong to a given security traded on a daily basis