Blog : What Nickel Ticks May Mean For Penny Stocks

by Ed Zwirn on August 29th, 2014

It looks like we may soon be ticking off many penny stock prices in nickels rather than pennies.

The Securities and Exchange Commission this week finally announced a pilot plan to study the impact of wider tick sizes for small-cap companies. The plan, which can be implemented as soon as next month, when a 21-day comment period expires, will test the effect of a 12-month widening of minimum quoting and trading increments on 1,200 companies meeting the following criteria:

-- A market capitalization of $5 billion or less.

-- An average daily trading volume of one million shares or less.

-- A closing share price of at least $2 at the start of the test period.

-- A closing price on each day of the "measurement period" of at least $1.50.

All of the stocks that have made the newsletter's Hot List over the past year meet the volume and market capitalization criteria, and exactly half of them most recently closed above $2.

Subscribers should therefore be sure to check out our daily updates for news of whether a stock you own (or are checking out) will make this list. Assuming your penny stock is one of the 1,200, it could be part of one of three test groups:

-- Pilot securities in the first test group will be quoted in 5 cent minimum increments, but be permitted to actually trade in any increment that is permitted today.

-- Group 2 will be quoted and traded at 5 cent minimum increments.

-- Group 3 will be subject to the same minimum quoting and trading increments, but would also be subject to a "trade at" requirement. A "trade at" requirement prevents price matching by a trading center that is not displaying the best bid or offer.

As this investment blog pointed out in May, a move to widen ticker sizes would mark a partial reversal of the decimalization rules set by the SEC 14 years ago, when it set trading increments at one penny, putting an end to the fractions that had heretofore been used to quote market value and execute trades.

Proponents at that time argued successfully (and correctly) that trading in penny increments would save investors money by narrowing bid-ask spreads and lessening space for middlemen. The counterargument, now in ascendancy, is that the compression of spreads has actually hurt the liquidity of some penny stocks and micro-caps. Turning the clock back would provide Wall Street with more money to pay for research and boost the profile for illiquid stocks.

Wider ticks are also supposed to boost the quality of investors in certain penny stocks. It is certainly the case that, in addition to saving investors money, the decimalization of the past 14 years has proved a godsend to rapid traders and at the same time discouraged banks and institutional investors fearful of being beaten out by a cent.

We have seen this quality concern play out in small companies anxious to attract a better class of investors. A NYSE-listed tech stock we profiled in April recently announced an eight-for-one reverse share split, bumping its price up from 66 cents to $5.28 at one fell swoop. The company cited its intention to "improve the strength and quality of its shareholder base."

It is far from clear that wider ticks may similarly help some penny stocks attract notice from a better class of investors and, to be fair, that is what this pilot is designed to test. Many penny stocks do fly under the radar, and any increase in analyst coverage can only help boost their liquidity.

That being said, Wall Street, which led the push for 2012's so-called Jumpstart Our Business Startups (JOBS) Act, which mandates the ticker pilot, stands to gain much if the results of the study lead to wider changes in small-cap stock trading. Individual investors, of course, stand to lose, but it remains to be seen whether this loss is outweighed by the better investment results they are supposed to get from more analyst coverage.

One thing is certain: The difference between a penny and a nickel is four cents. Even allowing for the additional money to be spent on more sellside research (assuming that is even a good thing) and political campaign contributions, there is still a penny or two to be pocketed in this deal. And small change has a way of adding up. Like the saying goes: "Pretty soon you're talking real money."