MicroCap and Penny Shares

Posted By Robert On Sunday, January 5th, 2014 With 0 Comments

Microcap (micro capitalization) refers to companies that are smaller than those described as smallcap. Smallcap is generally equated to NASDAQ SmallCap Market requirements. Microcap stocks have market capitalizations (outstanding shares X price per share) of less than $100 million, with $25 million being about average. Microcaps commonly have prices below $20/share and frequently have modest to low daily trading volume. However, companies with market capitalization as high as $300 million or even more may be considered microcaps by many mutual funds.


While offering higher profit potential than SmallCap and Listed stocks, investing in microcap stocks should be approached as riskier and deserves additional attention to basics. Although it is possible to make many times your initial investment, it should be considered that it is just as possible to lose most or all of the money you invested in the particular microcap. It is not usually expected that you would lose all of your money with SmallCap or Listed companies. What you can’t afford to lose, you should not invest in microcap. In such a case invest in something more stable with less risk until funds are available for risk investments.

However, attempting to avoid all risks is not very practical, and can be expected to diminish the overall portfolio performance. Sometimes an investor takes the position that they will not take any risk. This guarantees that their portfolio with suffer the “purchasing power risk”, which is to say that even though none of the stocks they own have gone down in price , the portfolio is diminished relative to the overall market performance and relative to inflation. Even modest inflation can be dramatically harmful. Four percent inflation compounded over 10 years makes a dollar today worth about 67¢, in terms of relative purchasing power.  Note also that for smaller firms earnings are more likely to be volatile from year to year.


  • Do your homework! (See the following paragraphs)
  • Do not put too much of your assets into any one stock. Diversify your investments, in particular the microcap portion.
  • Invest only available funds in a microcap stock, funds that you can afford to lose.
  • Keep abreast of developments and news about the company.
  • Review the microcap portion of your portfolio more frequently than the balance of the portfolio. The frequency will depend on circumstances and will vary from time to time, but at the same time, avoid over trading.

A multitude of sources, on the Web and elsewhere, are available to access information on small company stocks. It is the quality of this information that we must be concerned with. A stock tip you receive from conversation, the phone, Web site, or Internet news group, or chat site often sound exciting, however, you must do your homework. Becoming a good investor is not so much hard as it is tedious. It can be helpful to have your broker or advisor collect up the information which you are having difficulty accessing. The first information to acquire is the information provided by the company itself or through its representatives. Additionally, the following suggestions can strengthen your decision and ratify actions already taken when circumstances indicate.

  • Graph the stock price past performance. Graphs reveal much about what is going on with a stock. Has the stock price been steadily increasing or decreasing? Does the graph produce a generally smooth line? Look for the magnitude of price fluctuations. Are there new highs or new lows recently? Also, track the trading volume. Compare notable events to the trading volume for that day and correlate this behavior to daily news. Does it trade every day? This is considered part of technical analysis, and can give you valuable insight. There is more to technical analysis, such as patterns like head and shoulders, umbrella, etc, but as an investor, as opposed to a trader, it should be enough to complete some basic review of the price performance.
  • Find and read the company’s past press releases. The company’s press releases, while they are likely to be self-serving, are useful in finding out what is going on with a company and about future company potential.
  • Contact the Company. You are going to have questions about the company. Most companies have someone who will be prepared to answer your questions. Direct your call to the company’s investor relations department or person. You may be referred to the company’s relations firm. The contact person’s phone number is usually included in a current press release. If not, there are directories on the Web, for NASDAQ or Listed companies, you can contact the respective market. When you reach the right investor relations person, request an “investor package”. This ‘investor package” should include current and immediate past press releases, latest annual and quarterly reports, SEC Forms 10K and 10Q, and if available, media articles, sometimes videos, outside research reports, company product or service brochures, sales material, and investor brochures and promotional material. At this point in your initial phone call, unless there is some urgency, is will probably be more productive to defer questions until you receive the package, review the material, and then return a call to ask for further information or clarify points.
  • Read regulatory filings such as those found in the SEC Web site http:/ Look for the company’s annual 10K report and quarterly 10Q report and any offering filings such as S1’s, S8’s or SB1’s, if these have not been provided by the company. You should be familiar with the content of these filings so that you can request, from the company itself, essentially the same information when you are researching a “non-reporting company”. SEC filings are available for “reporting companies” and contain extensive information about a company that you may not be able to find anywhere else. All U.S. companies trading on NASDAQ, The AMEX, and The NYSE or any other U.S. exchange are fully reporting companies and will file these documents electronically using the http:/
  • However, a great many companies, many successful, worthwhile companies trading through the NASD OTCBB are non-reporting companies and do not file documents in the EDGAR system. These companies may not be “public” as defined by the ’33 and ’34 Act, but are in effect “publicly trade” through filing of SEC Form 211 under SEC Rule 15c2-11. These trades are executed in the OTCBB as if the company were “public” and fully reporting. In the case of these companies contact the company directly and ask for essentially the same information. If you question the quality or veracity of the information you get, it is time to move on and, if necessary, unwind any position you may have.
    • Commercial Research Reports, such as Standard and Poor’s, Moody’s, Fitch’s, Walker’s, Value Line, Morning Star, etc. are expensive for an individual investor. Fortunately, much of this information may be obtained from your broker or a public library.

Your Stock Transactions

Buying and Selling Stocks of OTC (over-the-counter) stocks is accomplished through market makers. It is a market makers function to stand ready as a willing buyer at a stated price, the bid and at the same time stand ready to sell at a stated price, the ask. Both the bid and ask are interdealer prices, firm to firm. The intrinsic purpose justifying market makers is to create liquidity for public stock positions. The market makers compensation for providing this liquidity is the difference between the stated prices, the bid and ask. This difference is called the “spread”.

The public customer will have a commission added to the ask for a purchase transaction or a commission deducted from the bid for a liquidation transaction. In the case where the market maker and the customers firm are the same firm the amount added is called a “mark-up” or “mark-down”. The effect to the customer is the same and the firm may not charge both a mark-up/mark-down and a commission on the same transaction.

Listed transactions, those occurring on an exchange, follow essential the same process, but with somewhat different terminology. Today the majority of OTC transactions are facilitated by electronic systems, most under the auspices of the NASD, i.e. NASDAQ & OTCBB, SOES, CAES, the ITC system, etc. Also, the “paperwork” and the record keeping is predominately facilitated through electronic means, such as the NSCC System, TARS, DTC System, etc. However, these are far more involved than an investor would need, or for that matter care to know.

To illustrate a typical transaction we will eliminate the above intricacies and follow it through from Customer Mr. Bear to Customer Ms. Bull. Customer Bear believes the stock is going to go down and therefore he will sell it. Customer Bull believes the stock will go up and will she buy it. Of course this is the fundamental disagreement implicit in every trade, otherwise there would be no trade, no market. Markets can be seen as a means of equalizing these disagreements in an orderly manner.

Customer Bear enters an order to sell 100 shares of XYZ stock with his Brokerage firm, Broker A. At approximately the same time, Customer Bull enters an order to buy 100 shares of XYZ with her Brokerage firm, Broker B. Broker M is a market maker for XYZ stock, and there will likely be several other market makers as well, but to keep it simple we will use Broker M for both sides of the transaction. In reality the firms will check the “box”, the electronic quotations services, to determine the best execution for each individual order.

Broker A contacts Market Maker M and determines that the price available is satisfactory. Our example is market orders. Broker A gives an order to Market Maker M in which Market Maker M will buy 100 shares of XYZ at the current bid, let’s say $10 per share.

Broker B also contacts Market Maker M and determines that the price available is acceptable. Broker B gives Market Maker M an order to Market Maker M in which Market Maker M will sell 100 shares XYX at the current ask, in our example $11 per share.

Broker A charges Customer Bear a commission of $.50 per share for handling his selling transaction. Broker B charges Customer Bull a commission of $.55 per share for handling his buying transaction. Market Maker M has earned a spread of $1 per share. Broker commissions and mark-up/mark-down are subject to the NASD 5% Guideline. Market maker spreads are not. Market competition for orders should keep spreads fair, based on volatility, trading activity, etc. of the stock.

Customer Bear receives a written transaction confirmation (confirm) in the amount of $950.00. Sale proceeds of $950.00 will be credited to his account on settlement date, three business after the trade. He has in effect paid a commission of $50.

Customer Bull receives a confirm in the amount of $1,055.00. Purchase costs of $1,055.00 will be charged to her account on settlement date. She has paid a commission of $55.00.

Using the NASD NASDAQ or OTCBB systems, all of this happens electronically at a verbal trade report is almost immediately available.

Quoted Interdealer Bid and Ask Prices and Customer Orders

Each market maker for any given stock will enter into the electronic system both a bid price and an ask price. Rules require that they honor these prices for a minimum number of shares. The highest buy price of all the market maker in the system becomes the “inside bid”. The highest price at which an order could be executed where a public customer is selling. The lowest ask price becomes the “inside ask”. The “inside quote”, the inside bid and the inside ask, are what you get when you request a stock quote. When a public customers limit order is entered into the system at a price to buy or sell and that price is between the inside quote prices, the public customer order will establish a new inside bid or ask as the case maybe. Thus, public customers can also effect the inside quotes. Rules also require those dealers quote on private systems, such as INSTINET, that are better than their publicly quoted price to publicly display those better prices.

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