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.
- 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.
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.