Penny Stocks: Cheap, But Sometimes You Get What You Pay For

June 1, 2009

In the world of investing, everybody is looking for the next Microsoft. Who wouldn’t want to find an unknown stock for next to nothing and watch it become the dominant name in its industry? The problem is that, for every Microsoft, there are thousands of other companies that go the way of the 8-track tape player.

A penny stock is a stock in which the price of a share is $5.00 or less. The low stock price may sound enticing, with shares that cheap you may feel you’re getting in on the ground floor, but there are things about many penny stocks that make them risky.

Lack of Information: If you wanted analysis and research on Xerox, you would have no problem finding that information. However, there are very few analysts or even press covering these new small stocks. These companies also have a tendency to not produce financial reports like the larger companies.

One way to combat this issue is to focus on stocks that trade on the premiere exchanges (Nasdaq Small Cap, Nasdaq National & AMEX).

Lack of Liquidity: These small stocks do not have great volume in terms of trading shares. In many cases there is little investor interest.

You want to find a stock that trades at least 20,000 shares a day, but the higher the better.

Too Good to be True: You get that phone call or receive that newsletter in the mail with a stock that “JUST CAN’T LOSE!!!” Oh yes it can and yes it will.

NEVER purchase a stock from a free newsletter or phone tip. These companies receive payments to do this and manipulate traders into a stock to move the price. Before you know it, the price is going in the wrong direction. This is precisely the reason why penny stocks have a bad name and makes it even more difficult to separate the stocks with promise from the rest.

There are good penny stocks out there. You must do your own due diligence on the stock itself and any newsletter/service that recommends it. Many of the good penny stocks are just like their larger counterparts, just smaller in scale. They have solid management, a strong business plan and a great product or service.

As with any other investment, it takes a little work and some education, but the pay off could be exponential.


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2 Responses to Penny Stocks: Cheap, But Sometimes You Get What You Pay For

  • Victor

    I agree with you 100%. You have to look at potential growth on this type of stock in terms of %return and not necessarily a $ amount. If you were to purchase a $3 stock that then went to $6, that is a 100% return. Compare that to a stock that you bought at $35.

    It’s all risky, and like going to Vegas, you must be prepared to lose it all if you want to win it all.

  • Will Lux

    Another problem is that it just doesn’t happen. Rarely will you ever see a stock jump up from say 3 dollars to 100 dollars. That kid of growth is unheard of. I agree that the pay off could be exponential, but what some investors don’t understand is exponential might not be as large as they think.