Micro-caps vs. penny stocks

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Q. What’s the difference between a micro-cap stock and a penny stock?
— Investor

A. Let’s first take a look at micro-cap stocks.

These were formerly called “penny stocks,” said Bill Connington of Connington Wealth Management in Paramus.

“They are small, relatively new companies, untested or offering one product, or perhaps having only one market and are usually traded at less the $8 per share,” Connington said. “They have a market capitalization of roughly $50 million to $300 million.”

He said while some micro-cap stocks may be legitimate investment opportunities, these stock by nature are very risky. Some of these companies have few resources, lack liquidity and fail to execute their business plan and go out of business, he said.

Some micro-cap stocks are traded over-the-counter with their prices quoted on the OTCBB or Pink Sheets. More established micro-caps are listed on the NASDAQ Capital Market or American Stock Exchange, he said.

Penny Stocks, as defined by the SEC, are stocks that trade for less than $5 a share, and most are less the $1 a share and are not traded on any of the main or regional U.S. stock exchanges, Connington said.

“They are often traded infrequently so their true value is unknown,” he said. “Penny stocks are fraught with risk and subject to fraudulent market manipulation because of their lack of formal regulation.”

Connington said penny stocks do not have to abide by SEC reporting rules and so the frequency of financial statements may be erratic or nonexistent.

“Sometimes it seems the only thing that penny stocks are releasing is press releases to generate some stock market excitement,” he said.

Penny stocks are bought and sold at a number of different prices, and they’re usually considered a high-risk investment because of their low prices, lack of liquidity, small market capitalization and wide bid-ask spread.

When evaluating whether or not to invest in a micro-cap or a penny stock, you have to be aware of pump and dump schemes, chat room misinformation and overall liquidity for not only the company you are looking at but for yourself, Connington said.

“Investing in these securities based on the information that is available means you are basically gambling with your money,” he said.

So when comparing micro-cap stocks and penny stocks, Connington said, the difference in risk is not much different, but micro-caps at least have some regulation and an exchange where you can get more solid information about them.

“These are not stocks that most investors should be investing in,” Connington said. “I know as an experienced financial advisor, I stay away from both of these types of investments. There isn’t enough information to make an informed prudent financial decision.”

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This story was first posted in February 2016.

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