Secondary Stock: What It is, How It Works

What Is a Secondary Stock?

A secondary stock is a public stock listing that is generally considered to be riskier than blue chips because it has a smaller market capitalization. The stock can relate to any type of company, in any industry. The primary definer of a secondary stock is the company's market cap, with any company's equity shares trading under a certain "large cap" level being considered a secondary stock.

A secondary stock may also be referred to as a second-tier stock.

Understanding Secondary Stock

Market capitalization, or market cap, is the market value of a company calculated by multiplying the total number of shares outstanding by the stock price. Secondary stocks are more commonly referred to as small-cap or micro-cap stocks, depending on their market capitalization. The market cap of secondary stocks thus typically lies below the $2 billion threshold, though this level may be a matter of subjective opinion.

The smaller market cap relates to the smaller size and profitability of the issuing firm. Because a company's market cap is a sign of a mature and stable investment, most market participants will view large-cap stock as less risky than secondary stock. This is because the latter is issued primarily by less established and less known companies. Since the issuing companies are not as established as blue-chip companies, secondary stocks tend to carry a higher level of volatility than large caps.

The higher volatility associated with secondary stocks can represent a trading opportunity for those eager to participate in any large upswing in the price of the stock. In effect, these stocks have the potential of generating significant gains on a relatively small investment. Indeed, since there is often a greater natural demand for large caps, investors may find themselves paying too high of a premium to acquire a share of these companies. As a result, investors may be wise to look toward secondary stocks for value.

Some secondary stocks are listed in the New York Stock Exchange (NYSE) but consist of nearly any stock traded in the over-the-counter (OTC) market as well as regional stock exchanges.

Secondary Stocks and Growth Potential

An important factor that can make secondary stocks stand out is accelerated earnings growth potential. Indeed, smaller companies are often poised for above-average growth, especially in sectors like technology and biotech.

In addition to giving companies a favorable profile among analysts and investors, healthy earnings growth gives the investment community hope that at some point these small-cap companies can capture more market share and become the market leaders, ultimately becoming large-cap companies.

Incidentally, strong earnings growth, especially when compared to the largest player's growth, is an indication of a secondary stock issuer’s ability to compete in the market space alongside incumbents and demonstrates the strength of its business model. Investors must determine whether a secondary stock can continue to grow and create a presence in a given market, or if the primary player in the industry, coupled with other extraneous macro- and microeconomic factors will ultimately put that company out of business.