How to Pick Micro-Cap Stocks

Research improves your chances of success when buying micro-cap stocks.

Research improves your chances of success when buying micro-cap stocks.

Every investor dreams of buying a micro-cap stock that turns out to be the next Microsoft. It has happened, and can happen to you, but there is a greater likelihood that you will lose at least some money. Picking a good micro-cap stock is both a science and an art. Truthfully, no matter how much research you devote to your pick, there is no way to foresee variables that can harm that company's stock price. You can improve your chances to make money, but be prepared to devote daily time to monitor the progress of your investment.

Definition

Companies with a market capitalization (number of shares outstanding multiplied by the stock price) of less than $1 billion are considered small-cap stocks. Micro-cap stocks have market capitalization of less than half that amount, although there are no set levels that indicate which is a micro-cap, mid-cap or small-cap stock. These stocks trade on the OTC Bulletin Board or the Pink Sheets and are normally called penny stocks.

Screening

Penny stock analysts use sophisticated screening tools, technical analysis and fundamental research to find stocks with the potential to outperform the market. You can do the same if you want to spend the time and effort. Many large online brokers provide access to excellent resources to help you. The first step is to apply stock screening tools to the over 10,000 stocks trading in the over-the-counter marketplace. If you have an interest in a particular industry, start your screening to identify stocks in that industry, then screen for stocks making earnings rather than losing money. Select 10 or 20 of the best performers to examine further.

Fundamentals

Read the latest press releases and the quarterly and annual reports of all your selected companies. These are available at the OTC Markets website or the SEC's Edgar database of corporate reports. Study each one for established earnings growth, new contracts or growing revenues, and for increases in stockholder equity. Many of these small companies are trading as a result of a reverse merger in which they buy the trading legal shell of a failed company as a way of going public. These transactions create considerable outstanding debt the surviving company converts to common stock over time. An indication that a company has gone through a reverse merger can be found in the company history section of the first quarterly or annual report. Such a company will have traded under one or more different names in the past. This is a danger sign because it indicates large blocks of stock may be overhanging the market, waiting for an opportunity to sell out.

Rumors

Check out your selected stocks on as many of the online stock bulletin boards as possible to see if there is an active stock bashing and promoting community at work. Online stock bulletin boards play an important part in spreading both false and true rumors about a stock, and an active board is often an indication of volatile trading. The information posted is not necessarily true, and most professional traders say they ignore what is posted there. That is also not necessarily true.

Technicals

Study the trading charts of any stocks you feel may be good investments before you buy. Look for higher highs and higher lows, a relatively consistent upward progression, and a lack of drastic price drops and increases. Volatility is good for day traders, but if you are inexperienced in penny stock investing, look for a chart that shows some trading stability. Also, check to see if you are buying at a relative high or low. If the stock is trading at a recent high price, wait till it has gone through a period of profit-taking before buying.

Practice

Paper-trade the stock for at least a couple of weeks to see how your stock behaves in the marketplace. Do not be afraid you will miss a big move; you can always buy in after other investors have taken their profits. Do not allow yourself to panic buy. Do not buy stock touted in emailed stock alerts promising big profits. Do not buy stock on tips from friends or relatives. By the time you hear of a hot stock, the opportunity is often already past.

About the Author

Victoria Duff specializes in entrepreneurial subjects, drawing on her experience as an acclaimed start-up facilitator, venture catalyst and investor relations manager. Since 1995 she has written many articles for e-zines and was a regular columnist for "Digital Coast Reporter" and "Developments Magazine." She holds a Bachelor of Arts in public administration from the University of California at Berkeley.

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