The legal definition of a “penny stock” is one trading under $5…the law makes no mention of market cap size, which is a mistake, since some stocks trading under $5 can have multi-billion dollar market caps. But we are not here to teach you the laws, rules, or regulations on penny stocks and micro caps (although we do on some other posts), we are here to explain, Why You Should Prefer Micro Cap Companies to Penny Stocks:
In short, the novice investor looking to invest in penny stocks, is looking for a cheap play. The attraction
here is that the volatility in the micro cap/penny stock market will lead to big gains. This is correct. A stock priced at $0.0001 has a great chance of double in price by gaining a fraction of a penny. If the stock goes to 1 cent, you made a killing. As most professional financial advisers will tell you (besides that the penny stock market is the riskiest investment you can make), is that price is only one element of what you should be looking at. The same stock trading at $0.0001 may have no business plan, or may have only one executive running the show, or no funding lined up. This is a pure speculation play, and not on the company, but betting on other investors will come into the stock and drive the price up.
The same bet or speculation trade can be placed on companies by looking at the market cap. If a company has a market cap of $1,000,000 it has a better shot of doubling than a company with a market cap of $1,000,000,000; no matter whether the trading price is at $0.01 or $50.00 (Penny Stock and Micro Cap Companies can double in size with a single investor joining and making a capital investment, or the company making a profitable run that increases the balance sheet favorably).
But neither of the two paragraphs below should be the sole basis of your analysis. The reason “Why You Should Prefer Micro Cap Companies to Penny Stocks” is because they are companies, and not just stocks. To often the novice gets wrapped up in the fast-trade life and appeal of extraordinary gains. This is possible and likely with solid small companies with a business plan, proper executives, and funding in place. The penny stock trader who wants large gains in his or her portfolio will invest in companies, and not stocks.
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