Whenever I get on the internet to learn about the market, I am flooded with advertisements selling classes. These classes often follow the same theme – they teach you how to become “rich” on penny and micro-cap stocks (sounds like the Wolf of Wall Street). Some people get lucky and do make money doing it. However, the vast majority are simply throwing money into a bottomless pit. Let’s jump into the explanation of why microcap stocks are included in our red flags.
The Formula
Like our other flags, we have kept it as simple as possible here by only having one line. The line evaluates companies whose average market cap over the past year is less than $100 million, aka micro-cap and penny stocks.
The Results
There have been a few spikes in low market cap companies, but as a group, they still netted an 8% loss annually on average. Worse yet, there is no argument that low market cap and penny stocks are far more volatile than the general market. That is reflected heavily by the 10.48% monthly standard deviation – over double the benchmark.
If you historically invested in only companies with market caps of less than $100 million, roughly 62% of the companies would have given you a negative return. Yes, there are those few gems. For example, PLUG could’ve returned your portfolio 2,625% over 189 days. But the vast majority of micro-cap stocks that you invest in will result in a net loss – even if you have those few great buys to level it out.
Takeaways
For those of you with smaller accounts who have been thinking about purchasing companies like this, you may want to rethink that decision. We urge you to read up on tried and proven investing methods. You will undoubtedly become a better investor by simply reading and implementing strategies from books like The Intelligent Investor. You will be able to find companies that cost less for you to own, and are more likely to make you a healthy profit in the long run.