It Will Pay You to Do Your Homework
For individual investors, the micro-cap universe may seem filled with opportunity. After all, with 6,300 companies to choose from, you’re bound to hit a winner. But you’re bound to hit a loser too--and probably more than one.
That’s why the typical mutual fund that invests in these tiny companies is 58% riskier than the average fund that invests in large U.S. companies, according to the mutual fund tracker Morningstar.
No wonder investors place the total market value of these 6,300 companies below that of just two of the giants, General Electric and Microsoft.
If you’re thinking of investing in this sector, don’t exacerbate the problem by confusing micro-caps with penny stocks. When we speak of micro-caps, we’re referring to companies whose shares are listed and traded on the major exchanges: the New York Stock Exchange, the American Stock Exchange or the Nasdaq Stock Market.
These companies must meet the basic financial requirements of those exchanges and are regulated by the Securities and Exchange Commission.
Penny stocks, on the other hand, don’t trade on the major exchanges. You might find these thinly traded shares on the OTC Bulletin Board, which is operated by Nasdaq but should not be confused with the Nasdaq Stock Market. Without the same regulations, penny stocks are more prone to fraud and abuse.
Now that you know what a micro-cap is, keep the following in mind before investing in individual stocks:
* Little research exists on micro-cap companies. A majority of micro-caps aren’t covered by even a single Wall Street analyst. Before investing in these companies, then, you may need to learn how to analyze a company’s income statements, balance sheets and statement of cash flows.
* Micro-caps are less liquid than large stocks. That means you may have difficulty selling your holdings, especially if your stock is crashing. Many micro-cap fund managers refuse to invest in companies with market caps of $50 million or less for this very reason.
* Some micro-caps are cheap because they are overlooked. Others are cheap because they deserve to be.
