I have noticed there is a lot of confusion about the difference between “small cap stocks” and “penny stocks.” Also, although the terms “microcap stocks” and “penny stocks” are often used interchangeably, these terms connote something very different – and not all penny stocks are microcap stocks. Please allow me to clarify the meaning of these confusing terms.
The difference has to do with price versus market capitalization (market cap).
When you hear terms like “small cap” and “microcap,” this is referring to one very specific attribute of a stock – the “market capitalization” which is also often times abbreviated as the “market cap.” The market capitalization is basically how much money a company has on hand. It is determined by multiplying the cost of a single share by the number of outstanding shares (those shares that have been issued and purchased by investors).
So, for example, if a company has issued 10 million shares of stocks and the current price of that stock is $5/share, the market capitalization of the company is 50 million.
The cut-off point for the market cap of large cap, mid cap, small cap, microcap, and nanocap stocks is a bit fuzzy – the exact cut-off will depend on your source. However, here are some general guidelines:
Large Cap Stocks: more than $10 billion
Mid Cap Stocks: between $1 billion and $10 billion
Small Cap Stocks: between $100 – $300 million and $1 billion
Micro Cap Stocks: between $10 million and $100 – $300 million
Nano Cap Stocks: below $10 – $50 million
The term “penny stock” technically has nothing to do with market cap and is really more of a reference to the price per share. The cut-off price for a stock to be considered a penny stock varies between $0.99 – $4.99. The SEC (the federal Securities Exchange Commission) considers any stock under $5/share a “penny stock.” However, some brokerages, money managers, financial experts and others will define a “penny stock” as any stock priced under $3 or under $1. If it’s under a $1/share, you can definitely call it a penny stock. If it is between $1 – $5 per share, you are in a grey area.
In practice, a penny stock usually falls between the lower end of a small cap stock and a nano cap stock with the majority being in the micro cap category. However, there have been notable examples of mid cap stocks falling into the penny stock price bracket. For example, Blockbuster had a market cap of more than $5 billion in 2002 which would have placed it in the mid cap bracket. However, the price of Blockbuster stock has fallen drastically since then and it now trades as a penny stock.
I think it’s important to note here that market cap and price per share are NOT the best way to judge investment potential. In fact, historically smaller cap stocks have out performed larger cap stocks by a long shot. This is especially true during hard economic times like we are experiencing now. In other words, if you were to invest the same amount of money in smaller caps versus larger caps and you picked your stocks at random, on average you would come out far ahead with a smaller cap investment.
Considering the above, if you carefully choose smaller cap stocks, i.e. penny stocks, you would have a considerably higher profit potential than you would have with larger cap stocks. With larger caps, a 10% annual gain is considered truly exceptional whereas a smart investor in penny stocks will see much larger gains. This is why I trade penny stocks – they have much more profit potential. Yes, they are a bit more risky but there are certainly ways to minimize this risk. For me, I have found the best way to minimize risk and pick highly profitable penny stocks is to let someone else do it for me! Of course, I always test the picks initially in a demo account.