How are penny stocks different from microcap stocks?

New Delhi: In the realm of the stock market, dominant players like Reliance Industries, TCS, HDFC Bank, ITC, and others often take centre stage. Nonetheless, smaller companies have the potential to yield significant profits for investors, albeit with a degree of risk.

These stocks are often categorized as microcaps and penny stocks. If you were to poll investors, the prevailing belief would be that microcaps and penny stocks are interchangeable terms. However, this is a misperception, even among seasoned investors. Although many microcaps do fall into the penny stock category, this is not universally true for all such shares.

How do you differ between penny stocks and microcaps?

Penny stocks are typically characterized by extremely low share prices, often falling below Rs 20 per share. They possess a small market capitalization and tend to have limited trading activity, with investments in these stocks driven by speculation and carrying a high level of risk.

In contrast, microcaps are comprised of the 250 largest stocks following the Nifty 500 index constituents, chosen based on their average full market capitalization, according to NSE. These stocks do not necessarily exhibit very low prices.

In fact, some microcaps are priced as high as Rs 3,000 or more per share. For instance, as of September 6, 2023, examples of such high-priced microcaps include Force Motors (Rs 3,468.70), Neuland Laboratories (Rs 3,740.00), and HIL (Rs 3,028). On the other hand, there are low-priced microcaps such as GTL Infra (Rs 0.75), Rattan Power (Rs 6.65), Jaiprakash Power (Rs 8.60), and Dish TV (Rs 21.20).

As of June 30, 2023, within the current composition of the Nifty Microcap 250, the most substantial microcap company boasted a market capitalization of approximately Rs 11,000 crore, while the smallest company had a market capitalization of around Rs 1,000 crore. The median market capitalization for microcaps in this index stands at roughly Rs 2,500 crore.

Should you invest in penny stocks?

Penny stocks are characterized by their exceptionally low trading prices. Among them, there are certain stocks referred to as “ultra penny stocks” that trade at or near the ₹1 mark. These stocks are often associated with companies facing financial difficulties.

Nonetheless, investing in ultra penny stocks can yield significant returns if the company's fortunes change, potentially turning the stock into a multibagger. It's worth noting, however, that due to the limited information and analysis available for these stocks, experts generally advise against investing in such companies if one's risk tolerance is low.

Is it worth investing in microcaps?

While microcaps are commonly associated with inherent risk and their earnings tend to exhibit volatility, it's important to note that a significant portion of these companies are, in fact, profitable.

As of March 31, 2023, out of the 250 microcap companies, a substantial 218 of them report profitability. Impressively, many microcaps have undergone remarkable transformations over time. Since 2005, approximately 106 companies have ascended to small-cap status, 27 have advanced to mid cap territory, and two have even achieved large-cap status.

Nonetheless, as previously mentioned, investing in microcaps carries a heightened level of risk, mainly due to the limited availability of public information about these companies, making it challenging to assess their prospects accurately.

While some of these companies successfully grow, others may encounter crises and falter. Therefore, experts typically caution against investing in microcaps if an investor's risk tolerance is low.