Home Beginner Market Structure Understanding The Basics Of Market Capitalization – Micro Cap

Understanding The Basics Of Market Capitalization – Micro Cap

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Introduction

The stock market is usually classified based on a company’s market capitalizations and also the sector it belongs to. The market capitalization is further classified into a large cap, mid cap, small cap, micro cap, and even nano cap. The companies with the highest market capitalization come under the large-cap and the companies having the least market capitalization come under the micro and nano cap. Let us go ahead and understand the micro-cap sector.

Understanding Market Capitalization

Going by to the definition, market capitalization is the dollar value of the company in the market. It is the market value of the outstanding shares of the company. Mathematically, the market capitalization of a company is evaluated as the product of the stock’s current price and the total number of outstanding shares it has. The stock’s current price changes continuously; hence, the market capitalization changes constantly as well. The share price does not determine the company’s capitalization. It is the number of shares that identifies it. A $1 worth stock can still be a large-cap stock if it has at least $10 billion shares. Therefore, the market capitalization of a company is an essential tool for investors and economic analysts in determining the value of a company.

What is a Micro Cap?

We know that the large caps, mid caps, and the small caps are the companies that have a market capitalization of $10 billion greater, $2 billion to $10 billion, and $300 million to $2 billion respectively. Similar is the micro-cap as well. They are the companies that have a market capitalization between $50 million and $300 million. For example, let’s say a company’s stock is trading at $1 and is having around 100 million shares available for trading. Therefore, the market capitalization of the company results to be $100 million, falling in the micro-cap category. Well, the numbers mentioned above can vary between brokers. Hence, the numbers mentioned above are just an approximation.

The Micro-caps, also nano caps for that matter, are known for their volatility. These stocks are generally the most volatile stocks compared to the other capitalizations. The volatility and risk factor go hand in hand. More the volatility more is the risk associated with the stock. Hence, micro-cap companies are the ones that carry the highest amount of risk. These companies do not have a strong history, assets, and sales. They also lack liquidity. Comparatively, these stocks are the least liquid stocks.

Another fact about micro caps is that there are more micro-cap stocks than large-cap stocks in the market. This might seem like a point in favor of the micro caps, but, that’s not the case. In fact, a large number of stocks imply that some of the stocks might be fraudulent stocks. Hence, research about micro caps is critical. However, as micro caps do not have to file regular financial reports with the SEC, information for research is not as readily available as large-cap companies, which again becomes a hurdle for investors to invest in the micro-cap companies.

Many micro caps trade on the pink sheets or the OTCBB (Over-The-Counter Bulletin Board) rather than trading on the national exchanges such as the New York Stock Exchange (NYSE). Due to this, there is generally very less amount of information available to the investor for analyzing the micro-cap stocks. However, there are exceptions. Based on market capitalization, some companies are classified as a micro cap. But, these seem to perform quite well in the exchange market. For example, Peoples Financial Services Corp is a community bank located in Pennsylvania. Unlike the other micro-cap stocks, this stock trades on the NASDAQ. They have a strong history of profits and also pay a dividend to their investors just like a large-cap company.

Are there benefits of investing in the Micro Cap companies?

Yes, indeed. Some stocks do show good growth in the market and offer some real benefits to the investors.

1. From nothing to everything: Some of the companies start as a micro-cap because of their capitalization. But, later on, they go on to become one of the best large-cap companies dominating the markets. However, there are only a handful number of companies that experience this growth. Hence, finding such a company could be quite difficult, but can turn out to be the company with the best returns in one’s portfolio.

2. Efficient and Focused: Micro-caps are generally compact in size and also have less number of employers. This serves as an advantage, as the company can work in a more focused manner and provide highly effective results. This observation is made by the investors, and they look forward to investing in these companies in expectation of better growth from them.

3. The benefit of Acquisition: There is a misconception in the market that the micro caps are unnoticed by the leader of the market. But, in reality, the big players always have an eye on the micro caps. A micro cap does not grow into a large cap on its own. Often, the large multi-national companies acquire these micro-cap companies which result in the stock prices to skyrocket. Therefore, for an investor, this is like hitting the jackpot.

Obstacles of investing in a Micro Cap

1. No dividends: Micro-caps are infants in the market. Hence, it is obvious that they do not pay dividends to their investors. The micro-cap companies want their stock to grow. So, they reinvest all the profits the company receives.

2. Low liquidity: This is one of the major disadvantages of investing in a micro cap. Micro-cap stocks are usually traded very thinly. As a result, the investor has to suffer significant bid-ask spreads for buying and selling the stock. Nevertheless, it takes days, or sometimes weeks to build up a large position. Again, the reason is due to its liquidity.

3. High Volatility: Due to the liquidity issue, sometimes, all it takes is a few hundreds of shares of buying and selling to move the stock price significantly. Therefore, one must be prepared for highly volatile moves.

Micro Cap indexes and ETFs in the United States & Europe

The most famous small-cap index in the US is the Russell Microcap Index. It is an index that is composed of around 1,550 small and micro-cap stocks. It includes the 1000 smallest stocks from the Russell 2000 and some other smaller stocks from the US-listed stocks. The main reason for designing this index was to represent a collection of the most genuine micro-cap stocks and to exclude OTCBB stocks and pink sheet securities. Other micro cap indexes include The Wilshire US Micro-Cap Index, MSCI USA Micro Cap Index, and the CRSP US Micro Cap Index. Furthermore, due to the issue of liquidity in the micro-cap stocks, investors can consider investing in an ETF. For example, iShares Micro-Cap ETF is an ETF which keeps track of the Russell Microcap Index. This way, investors can gain better access to micro-cap stocks. Likewise, in Europe, the MSCI Europe Micro Cap Index represents micro-caps across 15 Developed Market countries. The index covers approximately 1% of the free float-adjusted market capitalization across the Developed Markets equity universe in Europe.

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