Micro-Cap: Definition in Stock Investing, Risks Vs. Larger Caps

What Is a Micro Cap?

A micro-cap is a publicly-traded company in the U.S. that has a market capitalization between approximately $50 million and $300 million. Micro-cap companies have greater market capitalization than nano caps, and less than small-, mid-, large- and mega-cap corporations. Companies with larger market capitalization do not automatically have stock prices that are higher than those companies with smaller market capitalizations.

How a Micro Cap Works

Companies with less than $50 million in market capitalization are frequently referred to as nano caps. Both nano caps and micro caps are known for their volatility, and as such, tend to be considered riskier than companies with larger market capitalization. Market capitalization measures the market value of a company's outstanding shares, calculated by multiplying the stock's price by the total number of shares outstanding.

Microcaps also have a reputation for high risk because many have unproven products, no solid history, assets, sales, or operations. Lack of liquidity and a small shareholder base also expose them to massive price shocks. 

Being that micro-cap stocks have a market cap between $50 million and $300 million, investors must be ready for greater volatility and risk compared to the large-cap stocks in the S&P 500. However, during periods of bullish strength, micro caps tend to outperform their larger counterparts. For instance, the 10-year returns from 2011–2022 for the Dow Jones Select Micro-Cap Index were an annualized 9.99%, while the S&P 500 Index returned an annualized 11.13%.

Special Considerations

While there may be some U.S. micro-cap companies that rely on a heavy portion of their revenue coming from sources outside the U.S., the vast majority conducts all or most of their business within the U.S.

This is important because domestic companies that do not have operations overseas do not need to worry about currency fluctuations and the potential impact of conversion risks on earnings.

Micro-Cap vs. Larger-Cap

Another consideration is the fact that there are vastly more micro-cap stocks on the market than there are large- and giant-cap stocks. Overall, investors may not see the same level of readily available information as with larger stocks such as Apple (AAPL).

As a result, the limited information and vast quantity of micro-cap stocks on the market make research extremely important to avoid fraudulent stocks and other potential pitfalls. Because many micro-cap stocks do not have to file regular financial reports with the Securities and Exchange Commission (SEC), research becomes even more difficult. 

Criticism of Micro Caps

Many micro-cap stocks can be found on the over-the-counter (OTC) markets, such as the OTC Link LLC (OTC Link), rather than national exchanges such as the New York Stock Exchange (NYSE). Unlike stocks on national exchanges, companies on these exchanges do not have to meet minimum standards such as for net assets and numbers of shareholders. 

Microcaps also have another drawback in that investors need to pay attention to liquidity when researching smaller companies. Lack of regular analyst coverage and institutional buying are additional reasons why there is less liquidity in the micro-cap markets than in larger-cap stocks.

Overall, micro-cap stocks represent a high-risk, high-reward opportunity for investors who are willing to do more research on the company involved, to determine whether it is worth the investment. This could include contacting the company directly to get the answers to any questions.