The Lowdown On Penny Stocks

Successful companies aren't born, they're made and they have to work their way from humble beginnings and through the ranks just like everyone else. Unfortunately, some investors believe that finding the next "big thing" means scouring through penny stocks in the hope of finding the next Microsoft or Wal-Mart. Unfortunately, this strategy will prove to be unsuccessful in most cases. Read on to find out why pinning your hopes on penny stocks could leave you penniless.

SEE: How To Evaluate A Micro-Cap Company

Penny Stocks 101
The terms "penny stocks" and "micro-cap stocks" can be used interchangeably. Technically, micro-cap stocks are classified as such based on their market capitalizations , while penny stocks are looked at in terms of their price. Definitions vary, but in general, a stock with a market capitalization between $50 and $300 million is a micro cap. (Less than $50 million is a nano-cap .) According to the Securities & Exchange Commission (SEC), any stock under $5 is a penny stock. Again, definitions can vary; some set the cut-off point at $3, while others consider only those stocks trading at less than $1 to be a penny stock. We consider any stock that is trading on the pink sheets or over-the-counter bulletin board (OTCBB) to be a penny stock.

The main thing you have to know about penny/micro stocks is that they are much riskier than regular stocks.

A Fortune for a Penny?
What makes penny stocks risky? Four major factors make these securities riskier than blue chip stocks.

1. Lack of Information Available to the Public
The key to any successful investment strategy is acquiring enough tangible information to make informed decisions. For micro-cap stocks, information is much more difficult to find. Companies listed on the pink sheets are not required to file with the Securities and Exchange Commission (SEC) and are thus not as publicly scrutinized or regulated as the stocks represented on the New York Stock Exchange and the Nasdaq. Furthermore, much of the information available about micro-cap stocks is not from credible sources.

2. No Minimum Standards
Stocks on the OTCBB and pink sheets do not have to fulfill minimum standard requirements to remain on the exchange. Sometimes, this is why the stock is on one of these exchanges. Once a company can no longer maintain its position on one of the major exchanges, the company moves to one of these smaller exchanges. While the OTCBB does require companies to file timely documents with the SEC, the pink sheets have no such requirement. Minimum standards act as a safety cushion for some investors and as a benchmark for some companies.

3. Lack of History
Many of the companies considered to be micro-cap stocks are either newly formed or approaching bankruptcy. These companies will generally have poor track records or none at all. As you can imagine, this lack of historical information makes it difficult to determine a stock's potential.

4. Liquidity
When stocks don't have much liquidity , two problems arise: first, there is the possibility that you won't be able to sell the stock. If there is a low level of liquidity, it may be hard to find a buyer for a particular stock, and you may be required to lower your price until it is considered attractive to another buyer. Second, low liquidity levels provide opportunities for some traders to manipulate stock prices, which is done in many different ways - the easiest is to buy large amounts of stock, hype it up and then sell it after other investors find it attractive (also known as pump and dump ).

Penny-Baited Traps
Penny stocks have been a thorn in the side of the SEC for some time because lack of available information and poor liquidity make micro-cap stocks an easy target for fraudsters. There are many scams used to separate investors from their money. The most common include:

Biased Recommendations
Some micro-cap companies pay individuals to recommend the company stock in different media, such as newsletters, financial television and radio shows. You may receive spam email trying to persuade you to purchase particular stock. All emails, postings and recommendations of that kind should be taken with a grain of salt. Look to see if the issuers of the recommendations are being paid for their services as this is a giveaway of a bad investment. Also, make sure that any press releases aren't given falsely by people looking to influence the price of a stock.

Offshore Brokers
Under regulation S, the SEC permits companies selling stock outside the U.S. to foreign investors to be exempt from registering stock. These companies will typically sell the stock at a discount to offshore brokers who, in turn, sell them back to U.S. investors for a substantial profit. By cold calling a list of potential investors (investors with enough money to buy a particular stock) and providing attractive information, these dishonest brokers will use high-pressure " boiler room " sales tactics to persuade investors to purchase stock.

SEE: What is a boiler room operation?

The Penny Stock Fallacy
Two common fallacies pertaining to penny stocks are that many of today's stocks were once penny stocks and that there is a positive correlation between the number of stocks a person owns and his or her returns.

Investors who have fallen into the trap of the first fallacy believe Wal-Mart, Microsoft and many other large companies were once penny stocks that have appreciated to high dollar values. Many investors make this mistake because they are looking at the "adjusted stock price," which takes into account all stock splits . By taking a look at both Microsoft and Wal-Mart, you can see that the respective prices on their first days of trading were $21 and $16.50, even though the prices adjusted for splits was about eight cents and one cent, respectively. Rather than starting at a low market price, these companies actually started high, continually rising until they needed to be split.

The second reason that many investors may be attracted to penny stocks is the notion that there is more room for appreciation and more opportunity to own more stock. If a stock is at 10 cents and rises by five cents, you will have made a 50% return. This, together with the fact that a $1,000 investment can buy 10,000 shares, convinces investors that micro-cap stocks are a rapid, surefire way to increase profits. Unfortunately, people tend to see only the upside of penny stocks, while forgetting about the downside. A ten cent stock can just as easily go down by five cents and lose half its value. Most often, these stocks do not succeed, and there is a high probability that you will lose your entire investment.

The Bottom Line
Sure, some companies on the OTCBB and pink sheets might be good quality, and many OTCBB companies are working extremely hard to make their way up to the more reputable Nasdaq and NYSE. However, there are good stock opportunities out there that aren't trading for pennies. Penny stocks aren't a lost cause, but they are very high-risk investments that aren't suitable for all investors. If you can't resist the lure of micro caps, make sure you do extensive research and understand what you are getting into.



More From Investopedia

--

Get stories like this on the Yahoo app and discover more every day.
Download it now.
Loading...
  • NTSB has yet to interview injured engineer in deadly crash
    NTSB has yet to interview injured engineer in deadly crash Associated Press - 21 minutes ago

    National Transportation Safety Board investigators held off questioning the engineer in the deadly Hoboken train crash because of his injuries Friday and struggled to lift clues from the train's black ... … More »

  • The Latest: Investigators say train crew 'very cooperative'
    The Latest: Investigators say train crew 'very cooperative' Associated Press - 28 minutes ago

    The Latest on a commuter train that crashed into a station in New Jersey, killing one person and injuring more than 100 others (all times local): 7:20 p.m. The National Transportation Safety Board says ... … More »

  • PM May orders employment law review as labour market changes
    PM May orders employment law review as labour market changes Reuters - 35 minutes ago

    British Prime Minister Theresa May ordered a review of employment practices on Saturday, saying she wanted to ensure workers' rights were protected under changing business models and a growing trend towards flexible or self-employment. The review … More »

  • Hammond says Brexit deal should not harm economy - Telegraph
    Hammond says Brexit deal should not harm economy - Telegraph Reuters - 39 minutes ago

    British controls on immigration following the country's referendum decision to leave the European Union must not be damaging for the economy, finance minister Philip Hammond was quoted as saying in the Daily Telegraph story on Friday. Hammond told … More »

  • China's yuan joins elite club of IMF reserve currencies Reuters - 47 minutes ago

    China's yuan joins the International Monetary Fund's basket of reserve currencies on Saturday in a milestone for the government's campaign for recognition as a global economic power. It is the first time that a currency has been added to sit … More »

  • Stocks rebound in Deutsche Bank-led volatile trading
    Stocks rebound in Deutsche Bank-led volatile trading AFP News - 56 minutes ago

    US and eurozone shares pushed higher Friday in volatile trade driven by Deutsche Bank's negotiations to settle US charges over its sale of toxic mortgage bonds before the financial crisis. News that Deutsche Bank was close to a much lower … More »

  • Accounting software maker BlackLine files for IPO Reuters - 1 hour 11 minutes ago

    Los Angeles-based BlackLine, founded in 2001 by Chief Executive Therese Tucker, counts Coca-Cola Co (KO.N), Under Armour (UA.N) and Dow Chemical Co (DOW.N) among its 1,500 customers. Reuters reported last week that the company was preparing for an … More »

  • Florida Lottery plans major expansion under huge new deal Associated Press - 1 hour 26 minutes ago

    The Florida Lottery — which just registered more than $6 billion in annual sales — is in line for a large expansion due to a massive new contract that state officials signed this month. Lottery officials, ... … More »

  • Deutsche Bank pressure eases as US fine looks smaller
    Deutsche Bank pressure eases as US fine looks smaller AFP News - 1 hour 31 minutes ago

    Heavy market pressure on Deutsche Bank eased Friday as a knowledgeable source told AFP the US fine over toxic debt it sold would be only $5.4 billion, not the $14 billion originally demanded. A person familiar with the talks between Deutsche Bank … More »

  • A Deutsche Bank settlement overshadows U.S. equities
    A Deutsche Bank settlement overshadows U.S. equities Reuters - 1 hour 39 minutes ago

    Deutsche Bank will likely cast a pall over equity markets next week as the largest German lender navigates a possible multi-billion dollar settlement with the U.S. Department of Justice over the sale of mortgage-backed bonds. Deutsche shares traded … More »

  • A Yahoo insider believes the hackers could really have stolen over 1 billion accounts
    A Yahoo insider believes the hackers could really have stolen over 1 billion accounts Business Insider - 1 hour 40 minutes ago

    REUTERS/Ruben Sprich Yahoo CEO Marissa Mayer The actual … Continued The post A Yahoo insider believes the hackers could really have stolen over 1 billion accounts appeared first on Business Insider. … More »

  • IMF leader cites 'historic milestone' for China
    IMF leader cites 'historic milestone' for China Associated Press - 1 hour 46 minutes ago

    Christine Lagarde, the managing director of the International Monetary Fund, is calling the inclusion of China's renminbi as the fifth currency in an elite group of the world's reserve currencies an "important ... … More »

  • Chinese yuan set to join IMF's elite currency basket
    Chinese yuan set to join IMF's elite currency basket AFP News - 1 hour 49 minutes ago

    China's yuan is poised to enter the International Monetary Fund's elite SDR basket of currencies, elevating Beijing's banknotes into a family long exclusive to global reserve assets. A symbolic coup for policymakers in Beijing, the move represents … More »

  • Business Highlights Associated Press - 1 hour 53 minutes ago

    ___ Malls, stores consider new ways to protect shoppers More sophisticated cameras. Security robots. Customers feeling shaken by recent attacks at U.S. malls may not notice huge changes — but mall operators ... … More »

  • The only executive to hold a high-ranking position at both Uber and Lyft is leaving Uber
    The only executive to hold a high-ranking position at both Uber and Lyft is leaving Uber Business Insider - 1 hour 55 minutes ago

    Uber Uber’s VP of Driver Growth, Travis VanderZanden, … Continued The post The only executive to hold a high-ranking position at both Uber and Lyft is leaving Uber appeared first on Business Insider. … More »

  • Trump vs Miss Universe: White House race hits new low
    Trump vs Miss Universe: White House race hits new low AFP News - 2 hours 26 minutes ago

    Donald Trump urged voters on Friday to check out the supposed "sex tape" of a former Miss Universe backing his rival Hillary Clinton, provoking the Democrat to label him "unhinged" in a surreal new turn to the White House race. In a pre-dawn … More »

  • Data storage provider Nutanix soars in market debut
    Data storage provider Nutanix soars in market debut Reuters - 2 hours 28 minutes ago

    After getting strong encouragement from investors, the company kept nudging up the asking price for shares from the $11 to $13 range set early last week, co-founder and Chief Executive Officer Dheeraj Pandey said in an interview on Friday. … More »

  • Municipal-bond week in review: Yields sag then finish strong Associated Press - 2 hours 31 minutes ago

    Yields on municipal and Treasury bonds sagged this week on concerns about the health of Germany's largest bank, before retracing their steps on Friday. The 10-year yield on the AP Municipal Bond index ... … More »

  • Nutanix exceeds expectations in upsized IPO Reuters - 3 hours ago

    San Jose, California-based Nutanix's share price exceeds the $13.40 value last placed on its shares in a 2014 funding round, an upgrade encouraging for the many unprofitable technology companies that, like Nutanix, have been weary of testing public … More »

  • US stocks rally on Deutsche Bank deal AFP - 3 hours ago

    US stocks rose strongly Friday as financial shares surged on news that Deutsche Bank was near a settlement with US regulators over its sale of toxic mortgage bonds before the financial crisis. US-traded ... … More »

  • How the Dow Jones industrial average fared on Friday Associated Press - 3 hours ago

    U.S. stocks climbed Friday as banks made a rapid recovery following a steep fall a day ago. Investors hoped Deutsche Bank and the financial system in general were in better shape than they had feared. ... … More »

  • Global stocks jump, euro edges up as Deutsche Bank rebounds
    Global stocks jump, euro edges up as Deutsche Bank rebounds Reuters - 3 hours ago

    By Richard Leong NEW YORK (Reuters) - Stock prices across major markets rose on Friday, while the euro stabilized as Deutsche Bank's shares recovered from record lows on a report it is close to a deal ... … More »

  • Dutch summon Russian ambassador over MH17 comments
    Dutch summon Russian ambassador over MH17 comments AFP News - 3 hours ago

    Dutch Foreign Minister Bert Koenders has summoned Russia's ambassador over "unacceptable" comments by Moscow criticising a report into the downing of flight MH17, officials said on Friday. "Responding to the presentation of the initial findings... … More »

  • Oil up second straight month on OPEC-fuelled rally
    Oil up second straight month on OPEC-fuelled rally Reuters - 3 hours ago

    Oil prices settled mixed on Friday while posting their second straight monthly gain on OPEC's planned output cuts, even as scepticism about the cartel's pledge grew after data suggested another record high in its production. Brent crude settled up … More »

  • Stocks jump, euro edges up as Deutsche Bank rebounds
    Stocks jump, euro edges up as Deutsche Bank rebounds Reuters - 3 hours ago

    By Richard Leong NEW YORK (Reuters) - Stock prices across major markets rose on Friday, while the euro stabilized as Deutsche Bank's shares recovered from record lows on a report it is close to a deal ... … More »

 
Recent Quotes
Symbol Price Change % Chg 
Your most recently viewed tickers will automatically show up here if you type a ticker in the "Enter symbol/company" at the bottom of this module.
You need to enable your browser cookies to view your most recent quotes.
 
Sign-in to view quotes in your portfolios.

MARKET MOVERS

  • Most Actives
    Most Actives
    NamePriceChange% Chg
    0.152-0.008-5.00%
    N21.SI
    0.12+0.01+12.15%
    40F.SI
    0.115+0.003+2.68%
    40E.SI
    0.113+0.007+6.60%
    43E.SI
    3.97-0.05-1.24%
    Z74.SI
  • % Gainers
    % Gainers
    NamePriceChange% Chg
    0.186+0.025+15.53%
    AWS.SI
    0.12+0.01+12.15%
    40F.SI
    0.164+0.016+10.81%
    40N.SI
    1.35+0.11+8.43%
    U19.SI
    0.475+0.035+7.95%
    NC2.SI
  • % Losers
    % Losers
    NamePriceChange% Chg
    0.36-0.24-40.00%
    AWG.SI
    0.20-0.06-23.08%
    AWI.SI
    0.27-0.03-11.48%
    BQO.SI
    0.30-0.03-9.09%
    5VP.SI
    0.265-0.025-8.62%
    BKA.SI

Market Data

  • Currencies
    Currencies
    NamePriceChange% Chg
    1.3618-0.0022-0.16%
    USDSGD=X
    1.5296-0.0004-0.03%
    EURSGD=X
    1.7640-0.0041-0.23%
    GBPSGD=X
    74.1220+0.051+0.07%
    SGDJPY=X
    5.6879+0.0039+0.07%
    SGDHKD=X
    3.0355+0.0126+0.42%
    SGDMYR=X
    9,608.6318+65.9189+0.69%
    SGDIDR=X
    4.8930+0.006+0.12%
    SGDCNY=X
    1.0421+0.0012+0.12%
    AUDSGD=X
  • Commodities
    Commodities
    NamePriceChange% Chg
    1,318.80-7.20-0.54%
    GCZ16.CMX
    19.25+0.06+0.30%
    SIZ16.CMX
    94.00-1.01-1.06%
    ^XAU
    2.21+0.02+1.07%
    HGZ16.CMX
    43.85+0.41+0.94%
    CLV16.NYM
  • Bonds
    Bonds
    TreasuryYield (%)Yield Change
    1.16+0.04
    ^FVX
    1.61+0.05
    ^TNX
    2.34+0.06
    ^TYX