Penny Stock Investing (Risks, Rewards & Characteristics)
What is a Penny Stock
Equity investments are known as “Penny Stocks” are one of the riskiest investments that investors can participate in. Penny stocks are any stock that trades outside of the major stock exchanges and trade at prices generally less than $10.00 per share. Even though Penny Stock Investing can be hugely profitable, investors should also be aware that it is possible to lose their entire investment into a penny stock for any number of reasons.
The SEC characterizes a penny stock as a low price speculative security and may or may not trade on a securitized exchange. Many stocks may also be difficult to get updated price information; however there are listing services such as the OTCBB and Pink Sheet listing services which today’s average investor can find online. These investments are forms of public financing that generally, small startup companies use to grow and expand their business. The regulation of these types of securities is less stringent in terms of financial reporting requirements and minimum capitalization levels.
Investors over the years have had varying misplaced definitions of what is a “Penny Stock” and the inherent understanding that the name implies.
To be clear, the true definition of a penny stock is not necessarily just stocks that trade for less than a dollar. The SEC defines penny stocks here, and by this definition, an investor can come across these investment vehicles in many different markets and may trade for a few dollars per share or more.
Most important to note, however, is that many of the ones that trade in the OTC Markets and classify as penny stocks may not report their financials as actively as on other companies on listed exchanges. Therefore the transparency and risk associated with these companies elevate to a level whereby most of the time, it is not even prudent to even consider their investment worthiness.
The Good and the Bad
Smaller companies tend to raise capital through these markets first because of the lower reporting requirements. And also, often to save costs because sometimes these young or better said “developing” type companies need time to establish a more robust fundamental path that can take some time.
Unfortunately, this leads to the entry of many bad players who have no commitment to shareholders and use these markets as a way to milk investors through various “pump and dump” schemes. For this reason, regulatory bodies are more aware and quick to react to situations like these with costly penalties and regular public announcements of enforcement actions to curb the abuse.
Many companies, however, do commit to grow and also give investors value. You can find many foreign companies trade their stocks in the over the counter markets “OTC” where their local listed stocks of their country may not be available to domestic investors in other countries such as here in the US.
Take a company like Nintendo, for example, Symbol NTDOY that has been a long time gaming powerhouse out of Japan. Still, because most US investors do not have access to the Japanese markets, the OTC market provides a way to invest in the company. There are many examples like Nintendo, and no matter what country the stock may list and trade on, the OTC Markets have long been a way to have global exposure in case the company doesn’t have listed shares on US local exchanges like NYSE or Nasdaq markets.
Important Factors to Consider when Investing in Penny Stocks.
Factors for investors to consider when penny stock investing include a lack of liquidity (ability to sell the shares quickly or at fair prices); relaxed accounting standards, notification of ownership of shares or material changes of fundamental conditions which regulatory bodies design usually to protect shareholders from fraud.
There is the possibility that a Penny Stock investing can reward investors handsomely because the underlying company performs well by responsibly using the investment capital to grow. There are many case examples of large multi-national publicly traded companies who initially began as a Penny Stock; however, investors should be aware that this doesn’t happen often. In more cases than not, the exact opposite happens, and the stock loses value to trade worthless as the company goes out of business eventually.
Fraudulent practices are more inherent in these types of equity investments. One standard scheme is known as “pump and dump” refers to instances where a company is publicly touted as a “hot” stock because of favourable financial conditions or a new “hot” selling product or service. This exaggerated hype causes demand by investors who buy the stock in high volume, which drives the price of the stock higher all. At the same time, the individuals behind the scheme are selling their shares at this higher price so that when the excitement of the news is over or possibly even untrue the stock price falls drastically and investors lose their money.
Anytime an Investor hears the news, research or important information about a company or stock, they have to consider the credibility of the source of that information or what motivations that source may have to release that information.
When an investor wants to search out potential excellent investment opportunities in these low priced stocks, it can turn into a massive exercise. To scour through dozens upon dozens of web pages and financial websites and blogs to get relevant fundamental information when determining which companies are investment-worthy, have demonstrated track records of growth and shareholder return commitments, or any other related information.
These types of companies may only have IR (Investor Relations firms); these IR firms put out media and information for a fee, and sometimes it leads to biased type research. It may merely be just hyped up news or pie in the sky forecasts that can lead to later losses because a company doesn’t perform up to expectations or what was promoted by the IR firms.
As is the case for any investment vehicle, Investors should take many steps before investing in a penny stock.
The average to novice investor should always talk to a professional financial advisor to determine the suitability concerning risks associated with the investment and if that investor is prepared to lose their entire investment possibly.
Investors should always investigate the company itself to determine the viability of their product or service, management’s track record, as well as their profitability and financial strength. The marketability and competition for their product or service agent should also fall within the investor’s radar to determine if the investment can hold its value.
How can MarketXLS help in your Research
MarketXLS may come in to be a convenient resource with its hundreds of fundamental functions that can plugin into a list of penny stocks or other OTC stocks that you may get from the OTC Markets site.
Let’s say, for example; you want to track all stocks that are listed in the OTXQX or OTCQB tiers or even on the Pink sheet listed tier. If the company has financials they have reported and filed with the SEC or on the Edgar system, chances are MarketXLS will have that information and a history you can get as well.
MarketXLS can save endless hours when doing comparisons side by the side of groups of stocks. Whether they are low priced traditional exchange-listed or OTC listed, grouped by industry, sector, or any other characteristics you may want to compare with from a technical point of view. RSI, custom stocks returns between periods, Beta calculations, moving average data points, and the list goes on!!!.
Try out MarketXLS and open up a world of investment analysis possibilities not found on most modern trading or institutional research analysis platforms all in the familiar environment of Microsoft Excel.
For the latest updates in the rules described in this article, always refer to the SEC website, check with your broker and financial advisors.
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