There are a number of ways ASX shares can be categorised, including by size, sector and type of investment. Some examples of these categorisations include ASX dividend shares, defensive shares, blue-chip ASX shares and so on.
Another term, that anyone having seen the Hollywood movie 'The Wolf of Wall Street' would be familiar with, is 'penny stocks'. The term penny stocks is most commonly used in the United States but many people also use it when describing shares on the ASX. So what exactly are penny stocks?
What are penny stocks?
It's all about the share price.
Some businesses have very high share prices. For example, the CSL Limited (ASX: CSL) share price is currently around $280. CSL is definitely not a penny stock.
The definition of a penny stock in the US is any listed company with a share price under US$5. But in Australia, most people use the term to describe ASX businesses with share prices under $1. The term originated from back when low share prices were measured in pennies. Obviously, inflation and changes in currencies have altered the literal meaning of the term since then.
In Australia, the term penny stock is more commonly used to describe an ASX share with a very small market capitalisation, rather than simply a low share price.
Small-cap ASX shares may have a market cap of less than $2 billion. Microcap ASX shares typically have market caps under $300 million.
But, a share price doesn't necessarily tell an investor the whole story of how big a business is.
For example, Sayona Mining Ltd (ASX: SYA) has a share price of around 25 cents, so technically could be regarded as a penny stock. Yet its market cap is just over $2 billion according to the ASX.
The Telstra Corporation Ltd (ASX: TLS) share price is currently sitting at $3.96, under the $5 level used in the US definition of a penny stock. But it has a market cap of $45 billion.
And ASX industrial business Lycopodium Ltd (ASX: LYL) has a share price of well over $6, yet its market cap currently sits at just $259 million.
How is this possible?
It all depends on how many individual shares each business has on issue. If a business worth $100 million had 10 shares, for example, each share would be worth $10 million.
But, if that $100 million company had 100 million shares, then its share price would be just $1.
Are penny stocks good ASX investments?
Of course, it all depends on the business. Some investors are attracted to so-called penny stocks because of the potential for huge returns.
And some ASX penny stocks do indeed go on to become large businesses. Examples of these include Pilbara Minerals Ltd (ASX: PLS), Northern Star Resources Ltd (ASX: NST) and Altium Limited (ASX: ALU).
But, plenty more don't go on to deliver much of anything, other than shareholder losses. An example of the latter could include a mining explorer that burnt through all its cash before making a meaningful discovery. Or a biotech that couldn't get the necessary approvals for its drugs across the line.
So, just because a share price might look cheap, it is generally cheap for a reason. For me personally, when it comes to investing in small-cap ASX shares, I prefer to stick to those companies that already have a proven business model or service, but they may be quite early on in their growth journey.
I believe this approach still offers me the possibility of achieving significant growth but reduces the risk of a total investment wipeout that I could face if buying a highly speculative penny stock.
