I was on the phone with a friend of mine a few weeks ago — an experienced amateur investor who had several hundred thousand dollars in his brokerage account and years of trades under his belt.
He had always been a bit skittish on the topic of penny stocks, but after several notable successes, he warmed to the idea of committing a reasonable percentage of his portfolio to microcap stocks.
So it was a bit jarring to me when I started telling him about a particular tech stock I was in the process of acquiring and he asked the following question:
“How is a company that’s trading for over 4 bucks a penny stock?”
Now, in my business, this question comes around more than I want it to. In fact, every time one of my readers asks it, I get a bit worried.
When most people hear the words “penny stocks,” they tend to take it literally and assume the company in question is trading for five or 10 cents.
In reality, “penny stock” is just an unfortunate term. It applies to a class of stocks that many know as micro-capitalization companies, or microcaps.
If you’re reading this, then you’re probably familiar with that term — but did you know that a microcap company can be any company with a total market capitalization (total value of all outstanding shares) of $200 million or less?
Is it a Penny? Or is it a Dollar?
I know it seems counterintuitive that anything worth $200 million could be seen as “micro” or even “nano” (a company worth less than $50 million), but in a world where medium-sized companies are valued in the tens of billions, that’s reality.
When talking about the price of the stock, however, this is all almost irrelevant.
The reason is that the price of the stock is determined entirely by how the company’s board decides to organize its share structure.
A company worth a billion dollars could trade for $4 a share if it chooses to have 250 million shares outstanding — which isn’t an uncommon number of shares.
Or it could be trading for $40 if it chooses a more limited share structure.
A perfect example of this dynamic, oddly enough, comes from the exact opposite of a penny stock: Apple (NASDAQ: AAPL).
In 2014, the company decided to split its stock — which was then trading in the $600-a-share range — seven to one… So if you had 100 shares going into that day, you had 700 shares going out of it.
Change in total value of the company was 0%, but the shares were now more affordable and therefore, at least in the eyes of the directors, more accessible to the casual retail investor — a.k.a. people like you.
How and why boards choose to structure their shares is up to them — and their reasoning doesn’t have to make sense to us shareholders.
Small Companies Are Not All Alike
What this leaves us with is the odd paradox of “penny stock” companies that trade for well into the dollar-plus range.
Take 1347 Capital Corp. (NASDAQ: TFSC). It’s a $57 million company — almost a nanocap — that trades for more than $9.
Or Ace Aviation Holdings (OTC: ACEBF), a $102 million company that trades for a very unpenny-like $12.
These are all technically penny stocks, and yet their tight share structures make them seem like mainstream, mid- or large-cap companies.
That said, there are some crucial characteristics of these “expensive” penny stocks that set them apart from their cheaper, “true” penny stock counterparts.
You will see that companies that prefer to dress their microcap nature with a more blood pressure-soothing $3 or $4 share price are usually a bit different from their 20- to 50-cent brethren.
First of all, these companies are usually more actively traded — both in terms of shareholder value transferred and in raw volume.
The liquidity possessed by many of these companies qualifies them for exchanges like the NASDAQ, and not the typical over-the-counter or Canadian TSX-V listings you commonly see associated with true penny stocks.
And where there is liquidity, there is generally stability, which takes away from another defining characteristic of a true penny stock (something your more bold traders actually thirst for): volatility.
Whether you’re the gambling type who likes to live by the seat of his pants and ride double-digit percentage swings on a daily basis or you prefer to buy into small but established publicly traded companies with a lot of upside potential that require patience, remember this:
Both are technically penny stocks, but they’re as different as night and day — with distinct advantages and pitfalls to both.
– John Peterson