Analysts find it useful to group stocks by their market capitalization, because stocks of the same size tend to have similar characteristics and performance. Market cap is found by multiplying a stock’s share price by the number of shares outstanding – i.e. if IBM was trading at $100 per share, and it had 100 million shares outstanding, its market capitalization would be $10 billion.
In this article, we will examine micro cap stocks. These are companies with market caps below $300 million.
Micro cap stocks take the advantages and disadvantages of small cap stocks to an extreme:
1. High potential growth rates – Like small caps, micro caps are either selling a new product or service, or else they are well-established in a certain region and are looking to expand geographically. Unlike small caps, most micros haven’t started to enjoy fast growth rates. They are still plodding along before they hit critical mass and take off. This means that investors willing to take more of a risk have a chance to jump on-board early, and catch the full move.
2. Less information and analysis – While small caps may have some Wall Street analysts and followers, micro cap stocks suffer from a dearth of information. They are almost never owned by institutional investors. On the plus side, this means that mis-priced bargains are relatively plentiful. However, investors will have to spend more time investigating and doing research.
3. Very risky – Micro caps are the riskiest capitalization group because they are the most likely companies to lack stable cash flow, management talent, and infrastructure. They tend to be the most vulnerable to economic down turns and failed corporate strategy. Public investors may never have all the information necessary to sell off bad companies before the share prices tank.
4. Illiquid trading – Micro capitalization stocks may trade with thin volume. This increases trading expenses through wider bid-ask spreads. Since many micro caps do not trade on an exchange, retails brokers may charge extra commissions and/or fees. In the event of negative news, exiting a large position may be difficult and costly.
Micro cap stocks should only make up a small percentage of your portfolio. Remember that well-diversified portfolios contain stocks from all market cap categories.
Success in stock trading depends on both stock selection and having a proven system for knowing when to buy and sell.
The Stock Trading Riches system has been recommended by many investors because it’s easy to use and has a strong mathematical edge.
Praveen Puri has 20 years of trading and investment experience – including serving as a consultant to major insurance companies, banks, and the Chicago Board of Trade. He is the author of Stock Trading Riches, which details a mathematical stock trading method that isn’t exciting or “sexy”, but is extremely lucrative.
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