Section 1.3: Types of Common Stock

  • How to classify stocks by market capitalization:

    • Large-cap, mid-cap, small-cap, and penny stocks.

  • Penny stock rules and disclosure requirements for investors.

  • Established vs. new customers under penny stock rules.

Overview

  • Common stocks can be categorized based on the size of the issuing corporation, market capitalization, or share price.

  • Understanding these categories helps identify a company’s relative stability, growth potential, and risk level.

Market Capitalization (Market Cap)

  • Market Cap measures the total market value of a company’s outstanding stock.

  • Formula: 🧮 Market Capitalization = Outstanding Shares × Current Market Value (CMV)

  • It represents what investors believe the entire company is worth in the stock market.

Large-Cap Stocks Over $10 billion - Long-established, financially stable companies.- Often called blue-chip stocks.- Tend to pay consistent dividends and show steady growth. Examples: Apple, Microsoft, Johnson & Johnson.

Mid-Cap Stocks $2 billion – $10 billion - Companies in transition from growth to maturity.- Still expanding but not as large as blue-chips.- Offer a balance of growth and stability.

Small-Cap Stocks $250 million – $2 billion - Smaller, newer, or growth-oriented companies.- Higher growth potential, but also higher risk.- Can be more volatile and less liquid than large caps..

Penny Stock

  • A penny stock is a low-priced, unlisted security — typically trading below $5 per share and not listed on a major U.S. exchange (like NYSE or Nasdaq).

  • They are considered highly speculative and risky investments due to low liquidity and limited disclosure.

Regulation of Penny Stocks (SEC Rules)

  • Because of the high risk and history of fraud, the Securities and Exchange Commission (SEC) has strict disclosure and suitability requirements for penny stock transactions.

Penny

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Penny 〰️

Regulation of Penny Stock (SEC Rule)

1. Disclosure Requirements

  • Before selling a penny stock, the broker-dealer (BD) must:

    1. Provide the customer with a disclosure document detailing the risks.

    2. Obtain a signed and dated acknowledgment from the customer confirming receipt.

    3. Supply monthly account statements showing:

      • The market value and

      • Number of shares held in each penny stock position.

2. Suitability Requirements

  • Before executing a penny stock trade, the registered representative must:

    • Determine that the investment is suitable for the customer based on financial situation and investment objectives.

    • Have the customer sign and date a suitability statement confirming understanding of the risks.

3. Additional Required Disclosures

  • The broker-dealer must disclose:

    • The name of the penny stock.

    • The number of shares to be purchased.

    • The current market price.

    • The amount of commission that both the firm and the representative will receive.

Exemptions

Certain transactions are exempt from the penny stock suitability statement requirement, but not from disclosure.

Exempt Transactions

  • Established Customers (defined below).

  • Unsolicited Transactions (customer initiates without recommendation).

Established Customer Definition

  • A customer qualifies as established if:

    • They have maintained an account with the broker-dealer for at least one year (and made deposits), or

    • They have made at least three separate penny stock purchases (different issuers, different days).

💡 Important:

  • Suitability rules apply only to solicited transactions (e.g., during cold calls).
    Unsolicited trades — where the client initiates the trade — are exempt.

✅ Quick Review Summary

Market Cap Formula: = Outstanding Shares × Current Market Value

Large-Cap Stocks: $10B+; stable, blue-chip, dividend-paying

Mid-Cap Stocks: $2B–$10B; balanced growth and stability

Small-Cap Stocks: $250M–$2B; higher growth potential, higher risk

Penny Stocks: Unlisted, < $5/share, high risk, heavily regulated

Disclosure & Suitability: Required for solicited transactions; customers sign acknowledgment

Established Customer: 1-year account history or 3 prior penny stock purchases

Next Section

✺ Review questions ✺

  • Outstanding Shares × Current Market Value (CMV).

  • Over $10 billion.

  • Unlisted security under $5 per share.

  • Disclosure document, suitability determination, and signed acknowledgment.

  • Someone who’s had an account for at least one year or made three separate penny stock purchases with different issuers.