A company dealing in on-demand employee spending technologies traded stocks at $0.31 in 2001. Thirteen years later, they traded at $107.
While this epitomizes the drastic wins in penny stocks, finding such good penny stocks remains a challenge for many investors.
The question is, do profitable penny stocks exist or are they the unicorns of the stock market?
What Is a Penny Stock?
Previously, penny stocks were common stocks valued at less than a dollar. The SEC then modified this to include stocks valued under $5.Still, this value in itself makes them highly speculative and volatile.
What Makes Them Attractive?
1. Low purchase price
Their low pricing makes then appealing to beginners. This allows you to buy in bulk, without putting in as much as you would with normal stocks.
The low cost allows you not only to buy in bulk but to diversify, which means you spread your risk a lot better.
3. Ease of Buying
All you need to do as an investor is look at the listed stocks and do your own research to pick reputable companies.
4. Learning Curve
Penny stocks are highly volatile. This volatility means fast price fluctuations and shorter periods between buying and selling.
For an investor, this forces you to learn quick lessons, make mistakes and learn from them fairly quickly.
5. Ideal for Short Term Investors
People that want short term investments will find that penny stocks meet this requirement adequately. Penny stock’s volatility means price fluctuations are fast in either direction.
Despite their advantages, penny stocks get a bad rep. The myths and narrative peddled to get people into poorly performing stocks is one reason why.
Here is a look at the most common ones:
Myth 1: Companies Selling Penny Stocks Are the Next Big Thing
While this is true in some instances, it’s not true 100% of the time. If anything, occasionally penny stocks are used by unscrupulous investors to offload their stake before they crumble.
High potential companies tend to go the IPO way in a major stock exchange. This is highly regulated to ensure the investor is protected.
Myth 2: You Are Protected by SEC
Penny stocks lack the regulation major stock markets have. This opens it up to the occasional pump and dump schemes leaving people with massive losses, and at times, spurning several countries.
Even with the little oversight by government bodies, not all penny stocks comply with the minimal regulation.
Myth 3: Low Prices Are Important in Making Profits
Investing is a game of percentages as opposed to dollars. While the low price of penny stocks is attractive, it is not the only factor that can help you make a profit.
The concern should be their potential to escalate in price rather than the nominal price or number of shares.
Expensive stocks can perform, and cheap stocks can fail. The reverse is also true.
Myth 4: Volatility Is Good
While the volatility of these stocks is an advantage to some, it can be disadvantageous.
Say you have 20 sellers with 1,000 shares to offload but one buyer looking for 500 shares only. If one of the sellers is desperate to offload, the prices can be slashed significantly.
While volatility is a plus, being caught on the wrong side of it can be disastrous financially.
Myth 5: Penny Stocks Are Easy to Trade
While buying stocks is relatively easy, selling them is not. And this is half of the equation.
Because these stocks are thinly traded, it can take several days to offload. In this time, with their volatile nature, a drop in price can leave an investor with losses.
Can You Make in Penny Stocks?
While the minimal regulation and limited information from shell corporations create fertile grounds for scamming, the same still happens occasionally in the major markets.
How can you avoid being scammed and land some lucrative deals? Here are some suggestions.
Promotion vs. Research on Good Penny Stocks
At times, promoters hire newsletters to do flattering pieces on their penny stocks.
Most of these articles give inaccurate projections and at times distort actual information to make people view the stocks as plum investments.
One way to distinguish between promotion and research pieces is by reading the ‘disclosures’ on a report.
If the writer is being compensated for the report, that’s a red flag.
A company is only as good as its management.
While it’s unlikely to find the big names in the business world managing companies floating penny stocks, the caliber of management is a key factor.
So evaluate their past record including failures and successes.
Look at the Financial Information
Penny stocks don’t delve too deeply into their financials. Still, look at any available financial information. Evaluate their debt and liabilities; the lower, the better.
Go for Companies That Are Posting Positive Revenue Growth.
Look at records and analyze the ROI on specific stocks. Read more here to see how ROI factors into good investment decisions.
Gather as much information as you can find about a company. The far back you can trace its history, the better.
Similarly, stocks that the OTC counter advice ‘additional care’ and ‘due diligence’ should be off your consideration list.
Such stocks can be under scrutiny for criminal activity or promotional activities.
How to Trade Penny Stocks
You must understand finance and the telltales signs of a bad investment. Here are a few pointers towards penny stock investments:
- Diversify and limit your holdings
- Check trading volumes and liquidity
- Look at them as short term investments and know when to offload
- Comb through the filing print notes or the fine print
- Resist the herd mentality
Again, do not be led by greed. Always make decisions when you are sober.
Myth or Reality?
Are penny stocks with a good return a myth? These stocks suggest otherwise:
- After NASDAQ crashed, these stocks traded at $0.31, only to climb back to $107
- After the recession, Pier 1 stocks dropped to $0.11 before gaining positively to $20.64
- True Religion saw its stock trading at $32, up from$0.06
- American Axle and manufacturing stocks realized a 5000% gain for shareholders that bought at $0.04 in 2009 and sold later at $20
- Similarly, BJ’s stocks have gained from $1.00 to $30
The truth is that there is money to be made from these stocks.
To Jump or Not to Jump?
Finding good penny stocks puts on you the same responsibility as conventional stocks. These include due diligence, spreading the risk and putting in only what you can afford to lose.
Read this article to see how you can use debt to leverage your investment strategy.