16 Sep Microcaps, penny stocks and risk

Q. Are microcaps and penny stocks the same thing?
— Trader

A. Nope. They’re different, but there are times when a microcap can be a penny stock.

A microcap stock is a stock with a market capitalization of less than $250 or $300 million, said Howard Hook, a certified financial planner and certified public accountant with EKS Associates in Princeton.

“The market capitalization of a stock is the number of outstanding shares available to the public multiplied by the stock price,” he said.

Then there are penny stocks, which are stocks that trade at less than $5 per share, Hook said.

These could be microcaps if the number of outstanding shares is small enough, Hook said.

Let’s talk about where these kinds of stocks might fit into a portfolio.

Hook said trading in individual stocks in of itself is more risky than trading in mutual funds. He said trading in microcaps and penny stocks represents even a greater risk.

“While some microcaps or penny stocks turn out to be good investments, many do not,” he said. “These types of stocks do not trade as often as larger publicly-traded stocks, making it difficult at times to find a buyer at market price.”

This is referred to as “thinly traded,” and it typically drives the price down for investors looking to sell, Hook said.

“Smaller companies may find it harder to borrow funds for operations than larger companies, making it more difficult for small companies to grow or even to weather temporary business declines,” he said.

So if you’re looking at microcaps or penny stocks, do so with great care.

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This post was first published in September 2016.