What Is a Micro-Cap Stock?

So, what's the big deal?

Micro-cap stocks can provide thrilling highs but also stomach-churning lows. Small-caps and micro-caps are often considered riskier than their larger counterparts, primarily because they tend to be newer, less established companies. Just getting started on their long-term journey, they might have fewer resources, less access to capital markets, and less-experienced management teams.

You'll also find some former giants here, fading out as their products, services, or business models turn obsolete. Some climb back from that dangerous precipice, but successful turnaround stories are not very common.

On the flip side, these stocks can offer significant growth potential. Because they are small, there's plenty of room for growth, and even a small dollar-based increase in sales or earnings can lead to a hefty percentage gain. It's easier to multiply a small starting figure than a large one, after all. However, it's crucial to tread carefully and do your homework before diving in.

Can micro-caps be good investments?

If you're thinking of dipping your toes into the micro-cap stock pond, there are a few things to consider. First, due to their size, these stocks may not be as liquid as larger stocks, meaning it might be harder to buy or sell shares without affecting the stock's price.

It's like Heisenberg's famous uncertainty principle in particle physics. You can't measure both the speed and position of a particle with perfect accuracy, and you can't buy or sell illiquid stocks without affecting their stock price in the process.

Additionally, micro-cap stocks may not be as widely covered by analysts and the financial press, which can make it harder to gather reliable information about the company.

For the brave at heart who are willing to put in the time and research, investing in micro-cap stocks can be a rewarding endeavor. Industry titans like Netflix (NFLX +0.35%) and Monster Beverage (MNST -1.28%) were also micro-caps (or even nano-caps) once upon a time before they found the big ideas that took them into billion-dollar territory. If you found them at their lowest point and then held on to that investment through thick and thin, you're probably set for life by now.

And, of course, it's always a good idea to diversify your portfolio. Don't put all your eggs in one basket, as they say. Including a mix of different types of stocks can help spread out the risk and increase the potential for reward. For every long-term winner in the Netflix and Monster mold, you'll see dozens or even hundreds of failed launches going nowhere.

Whatever you invest in these promising but risky stocks could very well go to zero in the end, and you need to accept that potential outcome before you start.

Finding the hidden gems

How do you find these elusive micro-cap stocks, you ask? There are various stock screeners available that can help you filter stocks based on specific criteria, such as market capitalization, industry, and various financial metrics. Set the market cap to $300 million or less, and off you go.

Of course, then you need to separate the future winners from gadflies headed for a quick and painful exit. This is where financial analysis comes in. Consider the company's revenue growth, profitability, global expansion plans, unique products, and so forth -- these are the qualities that could take the stock price higher and grow the market cap, too. On the other hand, you should also account for head-to-head competitors, regulatory risks, the cost of doing business, and other business challenges. There is no such thing as a risk-free investment, especially in this crowded corner of Wall Street.

Don't put your hard-earned money to work until you can accept the stock's balance of pros and cons. If your analysis turns up a dark result, it's better to move on and find a better idea.