What Is a Penny Stock, Anyway?

Dear Person,

One question I get asked all the time is: What exactly is a penny stock?

The term implies that it's a stock trading for pennies, or at the very least less than a dollar, but therein lies one of the biggest misconceptions.

You see, share price, despite being the value most often discussed when it comes to stocks, has nothing to do with the valuation of a company — and it's the valuation, or the market capitalization, that actually determines whether a corporation is a penny stock or not.

For a company to be considered a penny stock, it has to fall into a category referred to as microcap (short for micro-capitalization).

These are typically companies whose total share value (number of shares outstanding multiplied by the value of the individual share) does not exceed a certain limit.

That limit is between $200 million and $300 million. Any company whose market capitalization falls between about $50 million and $200 million–$300 million qualifies as a microcap and is colloquially known as a penny stock.

Anything larger (between $300 million and $2 billion) is a small-cap company, and anything smaller than $50 million is known as a nanocap.

If this is confusing, don't worry, because it gets worse.

A $5 Penny Stock?

Since share price has little to do with a company's status as a penny stock, you can have penny stocks that trade for $1, $2, $5, even $10. It all depends on how the company's share structure is set up. 

For example, at the moment, I have a lithium exploration company in my personal holdings whose stock is trading for just a hair under $5.

Does this disqualify the company as a penny stock? No, because with only about 20 million or so shares outstanding, the company's total value is still well under $300 million and therefore qualifies under the most basic definition of penny stock.

On the other side of the spectrum, there are companies like this one, ioneer Ltd.

Currently trading for $0.51, you would think that this is a penny stock, but if you notice, in the bottom right corner of the image, the company's market capitalization is over $1 billion, which places it in the middle of the small-cap spectrum.

A $1 billion company with a stock trading at just $0.50 means that there are about 2 billion shares outstanding — a high share count, but, regardless, still a far cry from a microcap.

If ioneer Ltd. chose to consolidate its share count through a process called a reverse split, it could decrease the number of shares outstanding, raising the price of the individual share but not affecting the company's valuation.

Forget About Share Price — Focus on Market Capitalization

A 10-to-1 reverse split would result in a share price of $5.15 while maintaining the $1.077 billion market capitalization.

All of this is very important to know if you're interested in investing in microcap companies because it's the small, early-stage nature of these microcaps that most savvy investors are specifically seeking.

Small and early-stage generally means higher volatility, which means your investment can gain (or lose) larger chunks of its overall value much more suddenly than larger, more established firms.

Over the years, and especially since the emergence of the internet, penny stocks have earned themselves somewhat of a notorious reputation given their vulnerability to manipulation.

That does not mean that there are not very solid, highly prospective investments out there in the penny stock realm.

These are the fastest-moving, fastest-growing companies on the public markets, and though their investors need to be braver and calmer than most, the rewards are commensurate with the risk level.

Mark Zuckerberg Is One of the World's Most Successful Penny Stock Investors

Remember, all companies were, at one point, microcaps. Even modern giants like Facebook — now Meta Platforms, (NASDAQ: META) — Amazon (NASDAQ: AMZN), and Tesla (NASDAQ: TSLA) were, at one point, companies with micro market capitalizations.

The difference is that these three examples were still private when they carried such tiny valuations, and the investors who made the most money off them had to buy their shares privately, in exclusive financings, instead of publicly, through brokers or online trading platforms like E-Trade or TD Ameritrade.

That makes penny stocks a common man's equivalent to venture capitalism and, as such, the most potentially lucrative public investment you can make.

I've spent decades studying this often misunderstood class of companies and have spent almost as long trying to teach people about it.

If you want to learn more, I've put together a quick, easy-to-understand primer on the topic.

Check it out right here, completely free of charge and with no registration required.

Fortune favors the bold,

Alex Koyfman

Check us out on YouTube!

His flagship service, Microcap Insider, provides market-beating insights into some of the fastest moving, highest profit-potential companies available for public trading on the U.S. and Canadian exchanges. With more than 5 years of track record to back it up, Microcap Insider is the choice for the growth-minded investor. Alex contributes his thoughts and insights regularly to Energy and Capital. To learn more about Alex, click here.