Micro caps stocks, or stocks for companies with market capitalization of under $300 million, often represent excellent investment opportunities with above-average returns.
Investing with Mutual Funds
Often, these stocks are underrepresented in institutional portfolios. There are a handful of micro cap funds however, which invest exclusively in these types of stocks, and these funds often are able to deliver returns that are well above average. Investing in a micro cap mutual fund may be an excellent alternative for a new investor that is unfamiliar with the process of analyzing a stock, or may be uncomfortable placing a large percentage of a portfolio in any one given micro cap stock. The fund allows the investor to take advantage of a much larger pool of micro cap investments that is under professional management.
For those who want to do some investing directly, there are some excellent opportunities, and by following a few rules, some good profits to be taken by investing in micro cap stocks. Sometimes referred to as “penny stocks,” these are often not listed on the major exchanges. Whereas a traditional investor would probably never invest in a company that is not profitable, micro cap investors consider potential rather than current revenue streams of the company. If the company is in the red, it doesn’t mean it’s not a good investment. Consider some of the following factors:
- The company’s expenses. Many solid companies are in the red because of a quarter of unusually high expenses that may pertain to research and development. It may be money well-spent, which will lead to sales in the foreseeable future.
- Sales. Has the company spent money on building a good multichannel sales infrastructure? This too, is money well spent. Take a look at sales history, current orders, and any announcements the company has made about future orders.
- Production. Does the company have enough capacity to produce the goods it needs to fulfill orders and become profitable? Again, legitimate red ink may be a result of build-out in this area.
- Other Metrics. Of course, you should examine the same metrics you would with any other stock, including market capitalization, trading volume, volatility, and management experience.
Most of the mainstream analysts will not cover micro cap stocks, but there are some newsletters that specialize in this area. Nonetheless, you will have to rely on your own research and instincts much more than you would if you were investing in higher-end stocks listed on the major exchanges.
Micro cap stocks do tend to be more volatile, which for short-term investors is good. If a stock for example, has a 52-week range with a low of $0.10 and a high of $1.00, and it’s currently trading at the bottom end of the scale, this may present an opportunity to buy if there are no big negatives. There may be a solid reason for the dip, such as major expenses in anticipation of fulfilling a large order. If so, then it’s time to buy. On the other hand, there may be a reason for the dip that is not quite so positive, so do your research and make a determination.
Lastly, a rule that most stock investors live by is never to “put all your eggs in one basket.” Diversify in as many different stocks as you feel comfortable tracking. Out of a portfolio of 12 micro cap stocks, it’s very likely that at least one or two will go south — but if you have chosen well, the others will more than make up the difference.
Information is for educational purposes only and is not be interpreted as financial advice. This does not represent a recommendation to buy, sell, or hold any security. Consult your financial advisor.