A penny stock and a small-cap stock represent the shares of a company with low market capitalizations. However, there is a distinction between the two. A penny stock trades at a low price and low market capitalization, and it often trades over the counter. A small-cap stock is based on a company's market capitalizations and not its stock prices.
A penny stock is usually considered a high-risk investment due to its low price, lack of liquidity, small market capitalization and wide bid-ask spread. A penny stock generally trades below $5 a share and does not trade on major market exchanges such as the New York Stock Exchange and Nasdaq.
For example, assume company ABC is trading at $1 per share and is not listed on any national exchanges. Instead, it trades on the over-the-counter bulletin board. Therefore, company ABC's stock is considered a penny stock.
Conversely, a small-cap stock refers to a company's stock with a small market capitalization between $300 million and $2 billion. The market capitalization of a company is the market value, in dollars, of a publicly traded company and is calculated by multiplying its shares outstanding by its stock price.
Unlike a penny stock, a small-cap stock can have a price greater than $5. For example, assume company DEF is trading at $100 per share, has eight million shares outstanding and trades on the New York Stock Exchange. Therefore, company DEF is considered a small-cap stock because its market capitalization is $800 million, or $100*8 million, which is in between the limits of being classified as a small-cap stock.