The microcap is a term referring to a publicly traded company that has a market capitalization of less than about $300 million. Sometimes, companies with market values below $50 million are referred to as “nanocap.” The size of the companies that investors invest in is important for several reasons, as it plays a role in estimating the expected risks and rewards. Let’s take a more detailed look at what microcap is and its advantages and disadvantages for small companies.
Definition and Example of Microcap Stocks
A microcap is a publicly traded company that has a market capitalization ranging from about $250 million to $300 million. The total market value of all of the company’s shares is determined, and it changes over time based on the stock price or the number of shares. Microcap companies typically have fewer assets and lower trading volumes than large-cap companies. This makes them more volatile, and investors consider them riskier than large-cap stocks. They may also be susceptible to manipulation and fraud.
It can be difficult to obtain detailed information about microcap companies because many of them do not file public reports with the U.S. Securities and Exchange Commission (SEC). However, the high volatility in stock prices of microcap companies also means they can achieve greater gains.
An example of a microcap stock is Applied Optoelectronics (AAOI), a company that provides fiber optic networking products and is traded on NASDAQ. In mid-November 2021, AAOI shares were trading at about $6 per share, with a market value of approximately $163.8 million. Its share price was around $13 the previous year, which was more than double the stock price in mid-November, highlighting the high volatility of microcap stocks.
Note: Microcap stocks can be traded on major stock exchanges such as NASDAQ or the New York Stock Exchange, but many are traded on the over-the-counter (OTC) market. When microcap stocks trade for less than $5 per share, they are often referred to as “penny” stocks.
How Microcap Stocks Work
Although all investments carry some risk, microcap stocks and smaller nanocap stocks are among the most volatile types of securities. Many of these companies are still in the startup phase. They often have few assets, products still in development, are not profitable, and have minimal revenue.
Another reason microcap stocks are considered riskier is their low trading volume. Low trading volume makes it difficult for an investor to sell shares at the desired price. The low number of shares traded regularly means that any sizable transaction can significantly impact the stock price.
The U.S. Securities and Exchange Commission (SEC) warns investors to watch out for these red flags when investing in microcap stocks:
- Security trading suspensions by the SEC
- Significant assets but minimal revenue
- Large ownership stakes held by shareholders
- Unusual auditing issues
- Financial statements with odd items in the margins
Microcap Stocks vs. Large-Cap Stocks
One of the biggest differences between microcap stocks and large-cap stocks is that microcap stocks often have less information available to the public, especially those traded in OTC markets. Companies listed on OTCBB or in over-the-counter markets are not required to apply for listing or meet any minimum financial standards.
In contrast, large-cap stocks must file regular reports with the SEC. Large-cap stocks are typically closely followed by stock analysts who write about them regularly.
Advantages
Disadvantages of Microcap Stocks
For investors, there are several potential benefits and drawbacks of microcap stocks to consider.
Advantages
- Greater opportunity for higher returns: Smaller companies tend to experience greater volatility than larger companies, which can provide opportunities for larger profits.
- Diversification: Microcap companies can help improve diversification in a portfolio that primarily holds large-cap stocks.
- Low share price: Microcap stocks tend to have a lower entry barrier due to their generally low price.
- Opportunity to find undervalued companies: Investors may find undervalued companies among microcap offerings.
Disadvantages
- Higher risk: Microcap companies are typically less established and generate less revenue even compared to small-cap companies and significantly less than large-cap companies. They may not be able to survive during an economic downturn.
- Higher volatility: All stocks experience volatility, but microcap stocks tend to have much higher volatility, meaning their price can change dramatically in a short period.
- Prone to fraud and market manipulation: Microcap stocks can be easily manipulated through “pump and dump” schemes and other fraud. The increased risk of fraud is partially related to the fact that there is less public information available about them. Many microcap companies have a limited historical record.
- Less public information available: Companies with less than $10 million in assets are not required to file reports with the U.S. Securities and Exchange Commission (SEC). Microcap companies are also not widely covered by stock analysts, so it may be difficult to find detailed information about them.
For many investors, microcap stocks play an important role in diversifying their portfolios. If you are considering purchasing a microcap stock, be aware of the high risks and volatility associated with them.
Key Takeaways
Microcap stocks are publicly traded companies that have a market capitalization ranging from about $250 million to $300 million. The market capitalization of a company is the total market value of its shares, and it changes over time based on the stock price or the number of shares. Microcap stocks offer a greater opportunity for higher returns compared to large-cap stocks, but they also carry higher risks and volatility. It may be challenging to research detailed information about microcap companies due to the fact that many do not provide public reports to the U.S. Securities and Exchange Commission (SEC).
Source: https://www.thebalancemoney.com/what-is-a-microcap-5210655
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