I recently had a conversation with a friend who started investing not long ago. Her portfolio has a significant amount of penny stocks.
At that moment, I had mixed feelings.
On the one hand, I was proud that she was investing and taking action. On the other hand, I was disappointed that she was putting her hard-earned money in companies that I consider trash.
Many people who start investing fall into buying penny stocks without really understanding what they are. Sometimes they get burned so badly that they give up on investing altogether.
If they don’t get “burned” (lose most or all of their investment), they soon realize that most penny stocks don’t go anywhere and linger around the same price for a long time.
In this post, my mission is to educate you to reach your 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 first book I talk about this topic in lesson #24.
What exactly is a penny stock?
The Securities and Exchange Commission* (SEC) formal definition for a penny stock are those that trade for about $5 per share or less.
However, the most “popular” penny stocks trade for less than $1. They are generally companies that no one is familiar with but claim to be the “next big something.”
Most people that buy these stocks have no clue about how much money the business generates (if any), whether they have any debt, cash, sales, and other vital details.
They are essentially buying a lottery ticket and hoping for the best.
*The SEC is the government entity that regulates publicly traded companies.
Penny stocks trade very infrequently, meaning that you may very well be stuck with worthless shares that no one in “the market” will want to buy.
Penny stocks are considered speculative investments. Because most penny stocks are unregulated, the majority are not required by law to disburse any financial information to the public. 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 types of requirements.
For the most part, you’ll be investing blindly with no clear understanding of the business or going.
Based on the above, 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. Furthermore, those gains are often random and never sustainable.
And by the way – the “penny stocks world” has a whole lot of scammers. If you have ever heard of the phrase “pump and dump,” that’s where the term comes from. One main thing scammers do is ‘hype up’ a random ticker symbol to create demand. They do this by making up random stories and implementing marketing techniques.
The random demand will boost the stock price. Once these scammers see everyone is buying and the price is significantly higher, they will sell their shares and leave all those “followers” with nothing.
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 being monitored by a goverment agency that is there to protect investors.
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,
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