Penny Stocks Explained

Hello everyone!

Last weekend, I shared a post on cannabis stocks and how I feel about them. I briefly mentioned the topic of “penny stocks” and this is something I want to elaborate more on because it is also a common question I get.

Many people that start investing fall into the trap of buying penny stocks (without really understanding what they are) and sometimes get burned so badly, that they give up on investing altogether.

In this post, my mission is to educate you so that you can reach your own conclusions and make your own decisions about these kinds of investments.

Ever since I started my investing journey (over a decade ago!) I have stayed away from penny stocks. I consider them risky and speculative. If you have my book you might have come across a chapter where I talk about this. 

Before I get into the topic, I want to emphasize that I fully respect everyone’s approach towards the stock market. If someone is an advocate of penny stocks and has no problem putting their hard earned money in those kinds of investments, I respect that. However, it is something I personally stay away from.

If you are new to the investing world and are considering investing in penny stocks or it is something that has crossed your mind; take a few minutes to read some of the facts below. After you read it, decide for yourself if this is something you’d personally feel comfortable with.

Here we go:

What exactly is a penny stock?

The Securities and Exchange Commission* (SEC) formal definition for a penny stock is one that trades for about $5 per share or less. However, the most “popular” penny stocks trade for just cents on the dollar and are generally companies no one has ever heard about. Also, most people cannot explain how exactly the underlying company generates revenue, whether it has any profits or any other important financial factors.

*The SEC is the government entity that regulates publicly traded companies. 

Penny stocks trade very infrequently meaning that it may be difficult to find someone to purchase the stocks from you once you attain them, which means you may very well be stuck with worthless shares that no one in “the market” will want to buy from you.

Penny stocks are considered speculative investments. Because most penny stocks are unregulated, they are not required by law to disburse any financial information to the public and they are not regulated to the extent that legit, established securities are.

For instance,  public companies that are regulated and outside of the “penny stocks” spectrum, are required by law to provide information to the SEC year after year about every single thing that happens with the business. The information is shared with the public in the form of annual reports, quarterly reports, proxy statements, press releases, and the list goes on.

The extensive disclosure of information allows investors to obtain most of the information they may need to make an educated decision on whether or not the investment would be profitable. Many penny stocks do not have these type of requirements. For the most part, you’ll be investing blindly with no clear understanding of the business or where it is going. 

Based on the above, it is highly possible that you may lose all your money and because there is no such regulation, there’s nothing much you can do about it. As clearly noted in the SEC website:

“Investors in penny stocks should be prepared for the possibility that they may lose their whole investment (or an amount greater than their investment if they purchase penny stocks on margin)”.

While it may be true that some people get “lucky” and actually make money in penny stocks, these stories are rare. Remember that there are a lot of scam artists out there- if you have ever heard of the phrase “pump and dump” that’s where the term comes from. Experienced people in the business of scamming others with penny stocks can easily ‘hype up’ a random ticker symbol and when everyone is in, they will go ahead and sell, and leave you penniless.

If you want to add some “cheap” stocks to your portfolio, at least look into the following:

1. Do you recognize the underlying business behind the stock? Do you understand how that business makes money?

2. Are you able to find an annual report or quarterly report that you can read and which can help you familiarize yourself more with the business?

3. If you were to invest and the company goes under – how would you feel about it? Would you care or would you just see it as “play money”?

My thoughts …

You work hard for your money. You want your money to work hard for you. Whether you are a fairly new investor just learning and just getting started, or an experienced well-seasoned investor, I always recommend focusing on companies that are well-established within their respective industries and that have a clear and specific competitive advantage.

If you want your portfolio to have a bit more ‘edge’ or more ‘risk’ with a possible high potential; go for companies that actually follow the SEC guidelines and that are regulated. Even if they have not yet ‘proven’ themselves, at least you’ll have the peace of mind that every move they make will be completely public and transparent for you because they are regulated.

You won’t have to worry about waking up tomorrow and finding out the ‘penny stock’ that was supposed to make you wealthy, ran away with your money and your dreams. You also don’t want your money just sitting there in the ‘red’ while you blindly sit and wonder what will happen next. Who wants to be in that kind of situation?! I like to sleep well at night.

And that is all my friends. Thank you for reading!

TELL ME, What are YOUR thoughts on this topic? DO you have any questions about this? Let me know in the comments! 

Cheers to profits,

Mabel

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