Penny stocks occupy a very small, very specific corner of the market — one where few people dare step on a regular basis… and with good reason.
Risk goes up exponentially once you set foot into the universe of microcap companies, the main reason being that these companies are typically early-stage, pre-profitable firms looking to get a foothold in their respective industries.
Though you can find plenty of microcap stocks in the OTC markets and trade them using common online brokerage systems like Scottrade, for those who want access to the largest segment of this species, there is one special place: the TSX Venture Exchange.
Headquartered in Calgary, the TSX is home to a few thousand companies, with average market capitalizations under $50 million.
All together, these companies have a tiny fraction of the enterprise value of major exchanges like the NYSE.
Small, Exclusive… Potentially Dangerous
In 2010, for example, the TSX had a total market capitalization of just over $60 billion. By comparison, the companies of the New York Stock Exchange totaled more than $19 trillion — almost 300 times that of the TSX.
That means two things to investors: more risk and more potential.
Small companies inherently present larger upside than companies already operating on a global scale.
Tiny firms, with employees numbering in the dozens instead of thousands, all face an uphill battle but at the same time give investors an opportunity to get in earlier in the company’s life cycle.
These are companies with the potential to grow by factors in the hundreds, even thousands… small companies whose business models are often designed to engage a global market, but are currently only in the local or even planning stages.
These are not your Apples, Facebooks, or Googles. Correction: they are not today’s Apples, Facebooks, or Googles, but rather tomorrow’s.
It’s All in the Name
The nature of the exchange is in the name itself: venture.
These aren’t high dividend-returning blue chip companies. These aren’t 100-year-old brands. These are new, small, potentially doomed venture-level businesses taking their first swing at mass commercialization.
The TSX is also home to one particular segment of the market that often serves to raise the collective blood pressure of retail investors: mining.
Mark Twain once described a mining company as “a hole in the ground with a liar at the bottom.”
His 130-year-old joke still has a lot of truth to it, but at the same time, resource exploration and mining remains crucial to industrial development on all levels, and the earliest-stage companies out there bring out the greatest upside, especially in emerging resource markets like lithium and cobalt.
Trading TSX-listed companies doesn’t require actually trading on the TSX itself, a fact that confounds many investors.
Most TSX companies have mirror listings on the American OTC markets, allowing for retail investors to get a bite of the apple using the same online brokerage networks they use to buy their mainstream stocks.
Close, But Is It Close Enough?
The difference is usually two-fold. First of all, shares on the OTC are expressed in U.S. dollars, which at the moment are about 1.3 times stronger than Canadian.
Second of all, and more importantly, Canadian-based companies will trade more volume on the Canadian side.
OTC listings typically trade at a diminished volume to their TSX counterparts, making buying and selling more of a crapshoot.
Investors sometimes have to chase a stock to get it, and then, when it comes time to sell, have to chase buyers — leading to diminished profit margins.
While this isn’t always the case, especially during moments of heightened liquidity (when big news comes out), it is a common pitfall.
The moral of the story here is that TSX trading is not for everyone… not by a long shot.
For those who do choose to tread into this narrow bandwidth of investment possibilities, you might as well go all the way and make the transition to the Canadian side.
Until next time,
John Peterson
Pro Trader Today