Penny Stocks: The Worst Investment You Can Make
by Alexander Green, Oxford Club Investment Director
Monday, April 20, 2009: Issue #981
Due to the magnitude of the recent bear market, we’ve been able to buy a lot of fine companies for less than $10 a share. Many of them are already trading considerably higher.
Yet some readers want us to go all the way down to the cellar. “Why don’t you ever recommend penny stocks?” one subscriber asked. “After all, it’s easier for a 50 cent stock to go to $1 than for a $50 stock to go to $100.”
For starters, it’s not.
Over the years, dozens of studies have shown that lower priced stocks don’t do better than higher priced stocks. In fact, they do considerably worse.
Ironically, while it’s not easy for a 50 cent stock to go to $1, history shows that going from 50 cents to zero is like falling off a log.
Reasons Why Penny Stocks Stink
There are other reasons I won’t touch penny stocks with a barge pole:
- For starters, the vast majority of tiny, unprofitable companies are such ridiculous long shots they don’t even merit your attention. Most of these companies have little if anything in the way of profits, not to mention the first prerequisite: sales.
- Secondly, you could drive a cement mixer through the bid/ask spread on many of these shares. If a stock is offered at 30 cents and bid at 24 cents, for instance, you’re down 20% as soon as you get your trade confirmation. (And that’s before commissions.)
- Thirdly, penny stocks are thinly traded and easily manipulated. You may buy a penny stock and see it zip higher. But then try getting out. It’s pretty disheartening to know you can drive down the price of your stock simply by selling a couple thousand shares at market.
And then there are the outright scammers…
Penny Stock Scams & Penny Stock Promoters
Often referred to as a “pump and dump,” a penny stock scam is when the insiders talk the stock up on one hand while bailing out like there’s no tomorrow on the other. That’s usually because despite the great story – and make no mistake, the stories are always fabulous – the company’s genuine business prospects are usually nil.
But penny stock promoters want you to trust them, to believe in the hot tip.
If you’re going to evaluate a penny stock, here’s how the penny stock promoters would like you to do it:
- By recognizing the multi-billion dollar market they intend to operate in.
- By considering the enormous profits they’ll generate when their technology is finally commercialized.
- By noting the proven reserves of the mining company operating next door.
- By the preliminary results of their Phase I trials.
- By any criterion you can think of except what the company is actually earning… Because that figure is virtually always zero.
A Few Basic Penny Stock Precautions
If you insist on discovering these lessons for yourself, if you doubt my words, or for some reason are drawn to penny stocks like a moth to a flame, at least take a few basic precautions.
Start by reading the company’s most recent quarterly or annual report…
- Does it have sales or earnings?
- What kind of debt is it carrying?
- How long has the company been in business?
- Who are the people behind it?
- What is their track record?
- What is their rap sheet?
In other words, if you’re going to roll the dice, make sure it’s a genuine speculation, not just a mindless crapshoot.
Also, take a look at what the insiders are doing. If the insiders – the ones who seem unable to contain their enthusiasm for the company’s near-term prospects – are dumping the stock en masse, you know all you need to know.
Run.
Some will say I’m unduly pessimistic. (Penny stock promoters, especially.) And, clearly, a few successful companies did start out as penny stocks.
But for every success story there are hundreds of penny stocks whose charts bear an uncanny resemblance to the last flight of the Hindenburg.
In short, there are plenty of smart ways to invest your money. Toying with penny stocks, in my view, is one of the dumbest.
Good investing,
Alexander Green
P.S. My New Frontier Trader service is designed to capitalize on the incredible opportunities presenting themselves in emerging markets today. We’re seeing younger “American equivalents” of Microsoft, IBM, Google and other giants – in their infancy. Find out more about Alex’s New Frontier Trader.
Today’s Investment U Crib Sheet
Many of the analysts we talk to are starting to get a little more than concerned for the current rally and the possibility of a pullback. It would mean that we’re in a bear market rally, which is little more than a “head fake” for investors and traders. And it would mean that you might not even need penny stocks to put your assets at risk.
Consider the prices of oil and gold. Gold is at $873 an ounce, while oil is sitting around $50 a barrel. They seem remarkably calm for a charging bull market.
The fact of the matter is that as cautious investors, we need to prepare for the worst, even as we hope for the best. It’s a sentiment echoed by our own David Fessler yesterday – that we need to “Be Wary of Bank Stocks as the Other Shoe Drops.”
And earlier last week, Lou Basenese discussed a new way to hedge to value of your home should the value continue to drop. “How to Buy & Sell a Home on the NYSE“.
There is a saying about the proverbial “Wall of Worry” – the longer it lasts, the greater the likelihood that it’s real. With very few people discussing the possibility of a pullback, the better the chances are that we’ll see one.
- Understanding Earnings Surprises: What to Look For & Their Meaning For Investors
- Insider Selling: How to Profit From The Insiders’ Unfair Advantage
- Insider Buying: The Best Buy Signal You Can Get
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17 Responses to “Penny Stocks: The Worst Investment You Can Make”
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April 20th, 2009 at 12:29 pm
Every one of you financial advisers want your money first, then give us some advise. This has never worked for me. Tell you what-you give me the advise first and then if I make some gains on your advise, I’ll send you your fee.Why should this be any different than me buying something at a store. They give me the merchandise and then I pay them. It’s so easy to give past results, we don’t need that.
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Chas Reply:
April 20th, 2009 at 8:40 pm
What I do is backtest the results and see if that was a good pick or not at the time.
Numbers seldom lie.
I tried a few of the so-called good stock pickers and they were false starts, but I have a few good ones that have proven themselves over time. (15 to 25 yrs of trading)
Good-day
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Peter Danzo Reply:
April 21st, 2009 at 1:04 pm
Amen to the advice on penny stocks. I’ve been burned more times than I’d like to admit. There’s also another scam related to penny stocks. I recently got an unsolicited “energy investment newsletter” that described a company named Fidelis Energy as “the one energy stock you must own”, claiming all sorts of oi; and natural gas reserves at a time when prices were at a record high. I fell for it, hook, line, and sinker and invested $10,000 @ $.85/share, and you guessed it – it then dropped to $.50/share and is now worth $.00009/share. I’ve since gotten numerous similar “newsletters” and tracked them out of curiosity and of course they are now all worthless. So beware of any unsolicited “newsletters” by snail mail or E-mail.
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April 20th, 2009 at 12:48 pm
Hi Alex, I did read the article on Penny Stocks and I think it was well written and had lot of valuable info in it. Thanks
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April 20th, 2009 at 1:03 pm
Alex, thanks for your report on Penny stocks , I agree to a point but now with the market way down there is a lot of them out there and hope fully they meet your standards and you will be able to give us a few there must be some out there now that were high and because of the market is way down and they became penny stocks , What about this may be a one that doubles because of its out look . Other than That, your the Best. Thanks GENE JANSSEN
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April 20th, 2009 at 1:08 pm
I agree that there is a lot of penny stock junks, but in this meltdown I have found some good penny stock with some real profit in the last 60 days like F up 79%, ODP up 200%(made $60,000.00 still growing), EJ up 120%, CDE up 65%, APWR up 59%,CSR up 36% even BAC is up 30% I found ways to recoup most of my losses in my porfilo from the purchase of penny stock that have “52 week high” are a 1000% plus…So Alex I don’t think that dumb, I think as investor in this market condition we should consider all options even penny stocks to improve our bottom line.
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Bob Reply:
April 25th, 2009 at 1:43 pm
Thanks Geoffrey, I recently bought MDOR very low, and it has about tripled. The research looks good for continued growth.
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April 20th, 2009 at 1:13 pm
Amen to your remarks. For serious money, avoid penny stocks. Most have great rags to riches stories but that’s about all you are going to get. If you don’t believe it, make a hypothetical investment in a few penny stocks that you are itching to buy and monitor your results. Good luck.
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April 20th, 2009 at 1:30 pm
One thing to keep in mind, when you read something like, “you could have bought a share of xxx at 17 cents in 1970, and now it’s $50.” This stock very likely did not sell at 17 cents. That’s the split adjusted price. So WalMart, Microsoft, Dell, etc didn’t start as penny stocks. I think this misunderstanding perpetuates the myth of penny stocks doing well.
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April 20th, 2009 at 1:41 pm
This is good advice for people just starting out or with an itch to get rich quick but although I invest in companies less than $10 or even $1, I never consider them any more risky than Lehman or Wamu. Take VVTV for example, it was a fair company but they came under trouble with looming debt and sales. However, the current price has more than reflected their troubles and I must say it is one of the cheapest companies out there.
Insiders are buying heavily, debt has been delayed by 3 years, new contracts to increase margins.
Even with the latest quarter coming in at a terrible number, it didn’t go down that much.
Plenty of cash and operations support the business. That’s what people should also look for. These are Cheap Ben Graham stocks at its best which I also wrote about http://www.oldschoolvalue.com/featured/more-cheap-graham-stock-ideas/
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April 20th, 2009 at 4:38 pm
Sounds like a voice of reason speaking….finally!This is the first time I think I’ve ever seen the term “Penny Stock”, surrounded by words which add up to logic, reason, and just good advice. Thanks for a breath of fresh air!
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April 20th, 2009 at 8:33 pm
hi Alex,
I like to trade penny stocks and I make considerable amount of money with it.
One ceveat tho, You got to learn the rules and stick with them in this arena.(3 yrs developing my system)
I read a lot of books in this area and I do well with my trades.
You have your area of trade and I have mine.
They say, different strokes for different folks.
Happy trading.
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April 20th, 2009 at 8:43 pm
Alex: Thank you – thank you. I have never bought a penny stock though I have a few now! I can never get real informtion on them and, as you indicate, the spreads are terrible plus I do not like buying on the OTC or foreigh exchanges. Thanks again for the reimforcement.
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April 21st, 2009 at 12:36 am
Hi, i read the article on penny stocks..i think its a very good forum for the investors to actually get aware of what the nitty and gritty of stock market is… actually markets are not what we see them through our eyes, its essential to know the technicals behind it…
thank u
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April 25th, 2009 at 7:47 am
Forget about pennies…
Invest in proven, dividend stocks… I found a great one in NRT…
good luck
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April 30th, 2009 at 11:26 am
I bought Nuvo @ $0.075 for $20K worth (TSX: NRI). Waited for a about a year. I sold it at $0.195 (150% gain).
However, bought BWR @ 2.5 and now its 0.135.
You win some you loose alot. Stay away from Penny Stocks!!!!
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June 28th, 2009 at 10:45 pm
I am a bit nervous now that I have read this stuff. I am now trying Penny stocks and so far lost 13% on one investment, so i am thinking maybe to do more research before I invest. I am hoping to earn a living doing this, but don’t have the capital to spend on anything greater than 2 dollar a share. Hmmm….I guess this beats the casino which netted me losses in the 10s of thousands over a ten year period.
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