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Making Big Money in Micro Cap Stocks
Every investor’s dream is… to find a stock that not only doubles or triples in value… but increases 10-, 25-, 50- or even 100-fold. The best place to find that dream is in small, under-monitored micro-businesses that still have almost all of their growth ahead of them. Many, but not all, also have very low share prices, making them attractive for taking small bets with your speculative funds.
Some of those big payout dreams come true, but some can fizzle out and leave you with a pile of losses as you venture into risky micro cap territory.
If you don’t want to be part of the carnage, you need to take some safety precautions. You can really do well with these stocks, but you have to be careful. Here are some guidelines to follow:
Know how, when and what to buy
1) Make sure you understand the terms “penny stocks” versus “micro stocks.”
Brokers call any stock priced below $5 a penny stock; the term is used here to refer to stocks that are literally trading for pennies…even less than pennies. A few stocks priced below $0.25 to $0.50 are in profit; most are seriously spending money or have some other problem. The same can be said for many stocks below the dollar. A typical penny stock is a very small company with very illiquid shares, pre or very early stage revenue and little if any public information to sink your teeth into. “Highly speculative” or “absurdly speculative” are terms that come to mind when we think of these types of “penny stocks.”
If you really want to gamble, go to a casino… the odds are better.
If you want to invest in micro-cap stocks (market capitalizations of less than $300 million), look for companies that are more than even capable of doing so.
2) Look for a solid developing story.
Value investors can buy mid-cap to large-cap companies they’ve been ignoring and wait for Wall Street to notice them…usually when they start posting attractive numbers. This doesn’t work as well with micro caps. A small but good company can grind
In the dark for years before the market takes notice… and that may not be your timeline. Look for companies that are starting to get a little attention on some of the more well-known financial blogs, or have gained some amount of market exposure from leading small-cap editors, or have published research from a credible analyst…then dig into the underlying numbers to make sure they support the story.
3) You may want to hold off on buying microcap stocks until you’ve been trading for several years.
It takes time and experience to learn how to scale these smaller companies, and even more time and experience to master the impulses that often cause novice investors to buy high and sell low. However, if you’re sure you’re right, stick your toes in the water; but only risk what you can really afford to flush down the toilet.
4) Pay attention to the hype.
Reality hype stocks are generally classic “pump and dump” schemes: some promoter advertises an unknown stock that exceeds its value, makes a quick profit, and leaves a lot of new investors in the hands. The bigger the hype…the weaker the foundation.
This is not the time to put all your eggs in one basket. Micro-cap stocks ($50-300 million
market cap) and nano-cap (market cap less than $50 million) is more prone to disaster than larger companies, so you’ll have to allow for some silliness. Remember, all you need is for a few of these stocks to come alive and you could be doing very well. After all, your losers can’t go below zero, and your winners have no upside limit.
6) Never invest more in microcap stocks than you can afford to lose.
The price of excessive rewards on the upside…is increased risk on the downside.
7) Don’t let commissions eat into your profits.
Use an online discount broker and buy enough of each issue to ensure that the commission is not a significant percentage of your purchase price.
8.) Security Margin Screen:
• Don’t buy if the debt-to-equity ratio is higher than 0.5. Even better are companies with no debt at all…but that’s a challenge in the microcap space. This makes them much less vulnerable to sudden failures in the event of unexpected problems.
• Don’t buy if the company is bleeding money and it looks like the balance sheet might not last until next Wednesday. Ideally, a company should have positive earnings, even if it’s only a penny or two per share.
• if the company has reported profits, pay attention if they start to decrease; make sure you know WHY.
• A business may have positive profits but not generate enough cash to cover day-to-day expenses. If free cash flow is a negative number; find out WHY. If a small business spends money, it may not be around long enough to execute its plan…even if it’s a good plan.
It is not easy to find micro caps with all these features, but they do exist. Once you find it, look for even more evidence that it could be a winner:
• Look for insider buys. If they are buying based on inside information, that is a positive sign for us. In a small business, insiders are usually in a good position to know if the outlook is favorable.
• Find a company with many customers. If all the business comes from one or two major companies, it is more vulnerable.
• Find a large, growing market… a rising tide floats all boats.
• Low P/E ratios are great, but not always essential to finding a good buy in microcaps. The reason is that micro-caps that earn a penny or two per share can easily double or triple their earnings in a short period of time when they have a jump in growth, bringing the P/E back down to earth in a hurry. Conversely, a company earning $10 per share would have a harder time growing its earnings to $20 per share. The important thing here is that you know the story well enough to make an informed decision as to whether or not you think these doubled earnings will materialize.
Know when to sell… and lock in your profits
With micro caps, you want your winnings to flow as long as the story is favorable. There is no point in buying micro caps for 10-15% profit; when you take a big risk, you should expect a much higher reward than that.
On the other hand, if your stock doubles or triples in a short period of time, consider selling half, taking your money off the table and making a nice profit.
This is what we call… “Playing with the house’s money.”
With this strategy, you can still enjoy the momentum (assuming it continues) and brag, brag, brag… without any risk to your startup capital. You have already locked in your profit.
And if it loses power and goes to zero (unlikely, but possible), you’ve locked in your profit and can still brag about how smart you are.
You also need to give your losers some wiggle room, as microcap stocks can be extremely volatile. And it is not always possible to buy them at the right time. But if your pick has dropped 25% to 35%, consider selling unless it’s clear a reversal is imminent. We’ve found that a preset stop-loss can reduce the emotion on the descent and save some of your money for another run at a 10, 50 or even 100-bagger.
An informed, diversified, speculative investor can make a lot of money
Micro caps, but only by choosing them very carefully.
This sector is not for the faint of heart because the vast majority of these stocks will not make the grade. But if you follow a few guidelines like the ones we’ve listed here, you’ll definitely improve your chances of finding the ones you can get to the pay window. And then the bragging starts!!!
Editorial staff at MicroCap MarketPlace specializes in issues related to MicroCap and small cap investments.
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