Stock investing is a great way to make profit from extra money that people don’t want to waste by simply keeping them in the bank. It is a known fact that higher investments can produce higher potential gains, but how about people who are interested in investing but doesn’t have a large capital at their disposal? This is where investing in penny stocks enter. What are penny stocks and how do they work? Read this article to understand more about the investment that most people need to avoid.
What are penny stocks?
The definition of penny stocks may vary at times. Some say that these are stocks than are bought and sold for less than a dollar, thus they are called “penny stocks”. Others refer to them as securities that are trading for less than $5 per share. They are also known to be stocks issued by very small companies called micro caps, which are companies that have market capitalization between $50- $300 million.
Given all of these, penny stocks are usually not found on major exchanges. Most of them can only be traded on over-the-counter markets or OTCs, which are less formal and less regulated exchange markets where investors can find less-known and potentially lucrative securities.
Several companies fit in the category of penny stocks: starting companies with very little resources, failed companies that are on the verge of filing bankruptcy, companies that are typically too small to be quoted on the major exchanges or companies that got delisted for not meeting the requirements.
Characteristics of penny stocks:
Low share price – As pointed out by the first part of this article, penny stocks are bought and sold at a very low price. If the investment turns out to be a good one, investors with very low capital can be able to buy large volumes that have the potential to make promising returns.
Less available information – Unless if they are traded on major exchanges, most companies that issue penny stocks are subject to fewer regulatory rules. They are not required to submit regular company reports; therefore it is more difficult to find current and reliable information about them.
Rarely pay dividends – Given the very little equity produced by the company, it is not surprising that they don’t pay dividends to their shareholders.
Lack of history – Since penny stocks are issued by new companies or companies that are approaching bankruptcy, they either have no available records or generally have a poor track record.
Less liquid – Penny stocks may trade infrequently, thus making them illiquid and difficult to buy and sell without affecting the quoted price. A less liquid security results to force selling at unwanted prices.
Subject to fraudulent schemes – These stocks are often subject to price manipulators who purchase large quantities of stocks, then artificially inflate the price through false, misleading positive news. This is popularly known as the pump and dump scheme.
Very risky – Penny stocks are considered to be very risky for novice traders. They are susceptible to higher price swings or higher level of volatility resulting to higher potential reward and a higher level of risk. Extreme caution is advised if one would want to invest in them.
Should you buy penny stocks?
A lot would say to entirely avoid them. But this doesn’t hide the fact that there are also legitimate companies that happen to trade at low prices at the start. Some examples of companies that got big after selling at penny levels are Monster Beverage (MNST), Pier 1 (PIR), Ford Motor Co. (F), Medifast Inc. (MED), and a lot more.
Why not buy penny stocks if they could end up becoming profitable?
No one knows for sure what would happen in the future. Even a very thorough analysis won’t guarantee that you’d be able to recognize high potential penny stocks because most of them either have no submitted information or only have shady, manipulated reports. Because of these, the success of penny stocks is purely speculative. Investing in penny stocks is far more dangerous than buying shares from large, well-established companies.
How to raise the chances of making profits through penny stocks?
Look for companies that are legitimate businesses. These are companies that file regular financial reports and adequately disclose their business plans to investors. The companies aforementioned are legitimate companies that only happen to share a very dominant trait of most penny stocks – a low per-share price listing.
If one is planning to invest in penny stocks due to the low price, a better alternative would be exchange-traded funds or ETFs that are selling for a low price as well but can give you less risk. Penny stocks are more suitable for investors with a higher tolerance for risk. They may sound good in theory as they trade at discounted prices and have potential unlimited gains, but everyone needs to consider first the heightened risk. Penny stocks may be tempting to those who are looking to make a quick and cheap buck, but honestly the gains you can get doesn’t do justice to the risk involved.
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