What’s the Difference Between Small-Cap and Penny Stocks?
Many investors gravitate toward the well-known blue-chip stocks of large Fortune 500 companies. Putting money in the shares of these storied firms offers a strong sense of security. Industry giants like IBM, General Motors and Apple are three blue chips that attract billions of dollars. But what about small-cap issues? One of the indexes that specializes if these kinds of companies is the Russell 2000, composed exclusively of corporations with low capitalization amounts.
Penny stocks are defined by their price, not the issuing company’s capitalization rate. There are competing rangers you’ll see in the media, with most experts labeling a penny stock security one whose price is somewhere between $1 and $5. There’s more to it than that. Let’s take a closer look at these two types of securities.
What are Small-Cap Stocks?
There’s a simple definition for these shares, which are called small-cap if the entity’s total share price times the number of individual shares outstanding is between $300 million and $2 billion. If you crunch the numbers and they fall in that range, then you’re in the right category if you prefer smaller organizations for investment purposes.
What are Penny Stocks
Shares in the $1 to $5 range, regardless of capitalization or any other measure, are called penny stocks. In most cases, they are not traded on any of the major exchanges and aren’t sold by major brokerage firms. They’re also considered high-risk because their prices can fluctuate wildly and they sometimes drop off the charts after the issuing corporation closes its doors. Knowing which penny stocks to watch, and which to invest in, is a key component if you are going to take on this type of risk.
The risks for penny shares are obvious, but small-caps also come with some risk. Corporation listed on the Russell 2000, for example, often undergo huge price swings within a typical trading day. One advantage of blue chips is the stability of the parent company. That’s not always the case for newer, smaller-capitalized companies. Nevertheless, many experienced investors prefer the growth potential of both penny and small-cap shares.
For people who specialize in these riskier kinds of investments, the rewards can be impressive. Some of the tiniest companies often hit it big with a product, service or scientific breakthrough. When that happens, investors stand to make massive profits. Many market millionaires have accumulated their wealth by putting a significant amount of money in pennies and small-caps. While you have probably never heard of most $1 stocks, it’s likely you are familiar with many small-cap issues, like Etsy and World Wrestling Entertainment, Inc.
What should you do if you think this kind of strategy would work for you? The answer is one word: research. Unlike blue chips, these riskier issues mean you’re putting your money on the line with the chance it could disappear. If your goal is to put even a portion of your disposable funds into small stocks, spend plenty of time reviewing the company history, price trends, management profiles, recent corporate news, experts’ opinions and whatever else you can get your hands on. There is no substitute for heavy research in this volatile corner of the market.