Microcap stock
A microcap stock is a public company that has a market capitalization of roughly $50 million to $250 million. Companies with a market capitalization of less than $50 million are typically referred to as nanocap stocks. Many microcap and nanocap stocks are traded over-the-counter with their prices quoted on the OTCBB, OTC Link LLC, or the Pink Sheets. The larger, more established micro-caps are listed on the NASDAQ Capital Market or American Stock Exchange.
This is true in the US, but by contrast—in Australia, for example—nano-cap companies are commonly listed on the Australian Securities Exchange.
Microcap stocks are in many ways different from other stocks since they are from companies with a small market capitalization and are usually traded on stock exchanges that do not require minimum standards, such as a minimum amount of net assets or a minimum number of stock holders. In addition, these micro cap stock companies often have fewer resources to make their information available to the public. These micro cap stocks are less likely to be published and talked about by stockbrokers compared to larger public companies. Often, microcap stock companies will specialize in innovative products or services that may be unknown to the general public. In Australia, many of them are junior mining explorers.
Micro-cap and especially nano-cap stocks can sometimes experience volatility. Some of these companies fail to execute their business plans and go out of business. Fraud and market manipulation are not uncommon and the transaction costs in trading can be quite high. Pricing is more likely to be inefficient, since fewer institutional investors and analysts operate in this space, due to the relatively small dollar amounts involved and the lack of liquidity—in other words, how many trades are made per day.
Investors and finance experts have proposed microcaps can be good investments. David Maley of Ariel Investments argues that ample evidence indicates holding a portion of a portfolio in micro-cap stocks can offer advantages. Micro-caps as a group tend to out-perform stocks from larger companies over time, Daley notes, and micro-caps are not closely correlated with larger company stocks or index funds and thus potentially offset broader market volatility. Furthermore, micro-caps being relatively neglected by analysts offers more potential opportunities for value investors. Similarly, professor Jeremy J. Siegel of Wharton School of Business notes in his book Stocks for the Long Run how a review of American stock data from 1926 to 1996 found that the smallest quintile of stocks by capitalization outperformed the largest quintile by an average of almost 4% per year. But this over-performance was not consistent, with multi-year stretches of time when smaller company stocks under-performed relative to larger company stock.
Risks and regulatory concerns
Microcap stocks are generally considered higher risk than larger-capitalization equities due to factors such as limited financial disclosure, thin trading volumes, and greater susceptibility to price manipulation. According to the U.S. Securities and Exchange Commission, microcap companies may have little or no proven track record, lack substantial assets or revenues, and often trade in low volumes, which can cause relatively small trades to have a large impact on price movements. Such characteristics can make it difficult for investors to sell shares when desired and contribute to price volatility.Federal authorities also warn that fraud and market manipulation schemes, such as pump-and-dump promotions, have historically targeted microcap stocks because of the limited availability of reliable public information. In such schemes, prices can be artificially inflated through false or misleading statements before insiders sell their holdings, leaving other investors with losses.