Micro-Cap Investment: Pros and Cons

Overview: Stocks & Investment

The stock market game is not for everyone and certainly not for the uninformed. However, someone with the right strategies and research skills can create wealth even in chaotic times. Some of the wealthiest investors have made their fortune trading in volatile micro-cap stocks.

But knowing where to invest, how much to invest, and when to sell or trade does not come naturally to most investors. You’ll first need to understand what kind of stocks are out there so you can build your own plan.

Types of stocks

Before diving into each type of stock, you should know that each category is defined by the size of a company’s market capitalization, the total worth of all its shares.

Large-cap stocks refer to a market capitalization usually between $10 billion – $200 billion dollars.

Mid-cap stocks refer to a market capitalization range of about $2 billion – $10 billion dollars.

Small-cap stocks are usually defined as market capitalization between $300 million and $2 billion dollar mark.

A micro-cap refers to a company whose market capitalization is between approximately $50 million and $300 million.

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Why Should I Invest in Micro-Cap?

On the surface, you may think investing in large-cap companies makes the most sense since these companies tend to be more secure. Why not go with the easy bet and make a little money?

However, you could be missing out on undervalued stocks by ignoring smaller companies. And by missing out on those smaller companies, you could potentially miss out on a greater than expected return on your investment.

Another one of the pros of micro-cap investing is that there is less competition in the market, which gives you the advantage of possibly being the first to find a hidden gem. Micro-cap stock can achieve returns that beat the market.

The Risk of Micro-Cap Investing

Of course, there is risk involved with micro-cap investing. Smaller companies bring a greater risk of failure.

One of the big drawbacks of micro-caps is that they suffer from more market volatility than their counterparts. Although that may be unsurprising, it is something to keep in mind as you try to find the next “Amazon.” There will be volatility along the way.

Another drawback of the micro-cap market is that these companies are particularly vulnerable to pump and dump schemes. These fraudulent practices usually occur with shoddy start-ups, but larger companies have also been guilty of dishonest tactics to inflate stock prices (see: the story of Enron, for example).

These risks can be avoided with proper research, and in turn, allow you to take advantage of companies that the big investors ignore.

How Micro-Cap Investing Has Helped Enhance Returns

So how have micro-caps helped produce larger returns than expected?

Well, consider where some of the biggest companies today, such as Amazon, started. They didn’t just enter the market and blow up right away; it took time. Of course, Amazon had many opportunities to fail along the way.

But those who invested in these companies in the beginning, took the risk head-on, and it paid off big time.

That is the beauty of investing in miro-caps. You have a greater chance at investing a small amount of money and getting an outsized return.

Comparison: Microcap Investing vs Small-Cap Investing

The boundaries that separate the categories of stock are not firmly defined, and some will use micro-cap and small-cap interchangeably.

There is a difference between them, and understanding the difference can help you realize the risks involved with your investment.

While investors love small and micro-caps for the possibility of getting a greater return than expected, small-cap stocks hold slightly less risk than micro-caps.

It’s important to understand these differences so you know what to expect in terms of possible returns as well as volatility associated with each.

Take Away Message About Microcap Investing

At the end of the day, micro-cap investing could be the path to finding the next diamond in the rough. Unfortunately, that diamond could just be a dud as well.

Doing thorough research into any company you’re planning to invest in, especially smaller companies, is crucial.

Investing in micro-cap stocks is risky, but the possibility of a greater than expected returns is hard to ignore.

If you want to be in the know about micro-cap investing as well as other types of investing strategies and practices you can read more about it here.

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