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Both penny stocks and a small cap stocks may represent the shares of a company with low market capitalizations. That is, companies with relatively small valuations. However, there is an important distinction between these two categories: A penny stock trades at both a low price and low market capitalization, and often trades over-the-counter (OTC) instead of being listed on a stock exchange.

Meanwhile, a small cap stock is based solely on a company's market capitalizations and not its stock price or where it is listed. Indeed, many small cap stocks do trade on stock exchanges and are included in small cap indices.

Key Takeaways

  • Both penny stocks and small caps refer to company shares with relatively low market values.
  • Penny stocks are classified based upon their share price being lower than $5 per share and are often traded over-the-counter.
  • Small cap stocks are classified by their market value being under $2 billion, and are often listed on stock exchanges. Their share prices may also be above $5.

Penny Stocks

A penny stock refers to a small company's shares that typically trade for lower than $5 per share. Penny stocks are usually considered high-risk investments due to their low price, lack of liquidity, small market capitalization and wide bid-ask spread. Although some penny stocks trade on large exchanges such as the New York Stock Exchange (NYSE), most penny stocks trade via over-the-counter transaction via mechanisms like the OTC bulletin board (OTCBB), also known as the "pink sheets."

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.

Small Caps Stocks

Now let's consider the case of small cap stocks. A small cap stock refers to a company's stock with a small market capitalization between $250 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 and trade on a traditional stock exchange. For example, assume that a hypothetical company DEF is trading at $100 per share, has eight million shares outstanding, and trades on the New York Stock Exchange (NYSE). Therefore, company DEF is considered a small-cap stock because its market capitalization is $800 million ($100*8 million), which is in between the thresholds of value for being classified as a small-cap stock.

Note that the market capitalizations of a penny stock may often be less than $250 million. In general, companies with market caps less than $250 million are known as microcaps.