Micro-Cap Definition in Stock Investing Risks Vs Larger Caps
Micro-Cap: Definition in Stock Investing, Risks Vs. Larger Caps
What Is a Micro Cap?
A micro-cap is a publicly-traded company in the U.S. with a market capitalization between $50 million and $300 million. Micro-cap companies have greater market capitalization than nano caps and less than small, mid, large, and mega-cap corporations. Companies with larger market capitalization do not automatically have higher stock prices.
Key Takeaways
-A micro-cap is a stock with a market cap between $50 million and $300 million.
-Micro-cap stocks tend to have greater volatility and are inherently riskier than larger-cap stocks.
-Limited information on micro caps makes research important to avoid fraudulent stocks and potential pitfalls.
-Limited liquidity and lack of analyst coverage and institutional buyers are downsides to micro caps.
How a Micro Cap Works
Companies with less than $50 million in market capitalization are frequently referred to as nano caps. Both nano caps and micro caps are known for their volatility and are considered riskier than companies with larger market capitalization. Market capitalization measures a company’s market value, calculated by multiplying the stock’s price by the total number of outstanding shares.
Microcaps also have a reputation for high risk because many have unproven products, no solid history, assets, sales, or operations. Lack of liquidity and a small shareholder base expose them to massive price shocks.
Micro-cap stocks with a market cap between $50 million and $300 million have greater volatility and risk compared to large-cap stocks in the S&P 500. However, during bullish periods, micro caps tend to outperform larger counterparts. For instance, the 10-year returns from 2011–2022 for the Dow Jones Select Micro-Cap Index were an annualized 9.99%, while the S&P 500 Index returned an annualized 11.13%.
Special Considerations
Most U.S. micro-cap companies conduct all or most of their business within the U.S. This eliminates the worry of currency fluctuations and the potential impact of conversion risks on earnings.
Micro-Cap vs. Larger-Cap
There are significantly more micro-cap stocks on the market than large- and giant-cap stocks. Investors may not have the same level of readily available information as with larger stocks such as Apple (AAPL).
The limited information and vast quantity of micro-cap stocks make research extremely important to avoid fraudulent stocks and potential pitfalls. Many micro-cap stocks do not have to file regular financial reports with the Securities and Exchange Commission (SEC), making research even more difficult.
Criticism of Micro Caps
Many micro-cap stocks can be found on the over-the-counter (OTC) markets like the OTC Bulletin Board (OTCBB) and the OTC Link LLC (OTC Link) instead of national exchanges like the New York Stock Exchange (NYSE). Unlike stocks on national exchanges, companies on these exchanges do not have to meet minimum standards for net assets and numbers of shareholders.
Microcaps also have another drawback in that investors need to pay attention to liquidity when researching smaller companies. Lack of regular analyst coverage and institutional buying contributes to less liquidity in the micro-cap markets compared to larger-cap stocks.
Overall, micro-cap stocks represent a high-risk, high-reward opportunity for investors willing to do more research on the company involved to determine its worth. This could include contacting the company directly for answers to any questions.
