How to Assess Micro cap Stocks before Investing

The term “smaller is better” has become a cliché statement due its overuse. However, after witnessing the recent positive trending of micro- and small-cap stocks, one is apt to use that phrase. For years, investing on the 'big' stocks has been considered wise. However, the economic slowdown during the last few years has turned the tide. Big ideas and big investments fell apart and gave small returns. Later, when the market set out on the course of recovery, some investors started thinking 'out-of-the-box' and looked for other avenues. These avenues were riskier, yet more lucrative. Though a majority of investors remained with the safer options (traditional equity and mutual funds), risk-takers cashed in by gaining significantly on the thriving micro-cap market.

Why investors go for risky investments

It's true that there is higher risk involved with micro-caps. These stocks may plunge in a matter of weeks, and their impact could be much higher than the large-caps. Though, amidst such a bleak situation, several individual micro-caps have done reasonably well over their peer stocks. During better times, investors witnessed a different scenario where 300% to 400% gains have become common. Some even give exorbitantly high returns. In October of 2013, NASDAQ published a report that contained the data on a 52-week gain by various micro-cap stocks. The highest gain recorded was 800% by ACADIA Pharma (ACAD). The other major gains were 597% by Corporate Resource Services (CRRS), 568% by Revolution Lighting (RVLT), 508% by Aegerion Pharma (AEGR), 497% by Tesla (TSLA), and the list goes on.

Assessing Micro Caps

Micro-caps don’t usually get regular research coverage as in the case of large-cap stocks. So, as an investor, it may take more time and effort to find useful resources of information. These resources may not be able to advise you about the best methods to create a portfolio for building positions in the market. Since most of these stocks are not listed, they have much lesser visibility and have fewer research reports than the large stocks. It means you need to do research on your own, and such research should be done carefully focusing on improving liquidity of these stocks. Micro-caps typically lack liquidity, and thus attracts less attention from analysts in terms of finding informational content.

The best approach individual investors can take is to analyze a micro-cap company by checking the current stock price and its trending during the last 52-weeks. The fluctuations in the trading range may indicate a lack of stability. However, it can’t be conclusive because these stocks often hover between extreme ranges. Check for price/earnings ratios and try to notice whether the stock is cheap or expensive. Review a company’s financial statements for its net profit and the debt levels compared to the company’s capital base. There are a handful of websites available that provide relevant updates on micro-caps including featured stocks. This could provide good framework to the investors to create a portfolio. You can also subscribe to these websites for their micro cap stock picks or newsletters, as this will provide a steady flow of information as changes take place in the market.