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Penny Stocks - Are They A Good Investment?

Penny stocks are stocks that trade for less than one dollar.  Is buying a penny stock a good investment?  Let's discuss the pros and cons of buying penny stocks.

First, all penny stocks are different.  Some penny stocks are legitimate companies that have fallen on bad times and their stock prices have declined below a dollar.  While other penny stocks are companies that have been delisted, abandoned, and then purchased from someone else for hundredths of a penny per share.  They may or may not be legitimate, and because they are not listed on a major exchange, they are not audited and held to the same standards as listed securities.  Finding out if a penny stock is legitimate is the most important and hardest thing to do.  Many penny stock companies do not have full disclosure and do not have investor relations departments to contact.  Before investing in a penny stock, do your research and make sure the company is legitimate.  Find out who buys their products or services and call them to ask questions and to make sure they really have a product.

Second, investing in penny stocks is beyond risky!  Because the stocks are not listed on a major exchange, they typically have low trading volume and can sometimes trade for less than a penny.  The fact that they are illiquid and trade for pennies, means they can move a lot in terms of percentage.  For example, a stock that trades for 10 cents and has a bid / ask spread of 1 cent, can change by 10% depending on whether the buying or selling price was reported.  Furthermore, average trading volumes can be so low that an order of a few thousand shares can move the price by more than 10% (sometimes even more).  This may sound attractive, but remember that when you need to sell, you may have to take a 10-20% reduction in price to get rid of your shares.

Also, investing in penny stocks is often about rumors and "pump and dump" schemes.  To get attention to a penny stock, penny stock investors often send out mass emails about the stocks they own to get attention to their stock.  A few purchases and the stock soars.  Then people getting the letter think its a good buy and the stock surges more.  The people behind the email or website that promoted the penny stock sells and then, a few days or weeks later, the stock is forgotten about and back below where you bought it.  It is very rare that a penny stock ever does well enough to regain listing on a major exchange.  For an example of penny stock advertising, just search for "penny stock" and look at the sponsored listings in the search results.

So, with all the manipulation, lack of regulation, low liquidity and difficulty of getting accurate information, do penny stocks make a good investment?  We say NO.  In fact, buying penny stocks are usually not an investment at all, but rather a speculation or gamble that may or may not pay off.  So, unless you are looking to speculate and really know what you are doing, we recommend avoiding penny stocks.


 

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