According to the U.S. Securities and Exchange Commission, penny stocks or micro-cap stocks are equities that trade below $5.00 per share, although the cut-off amount can be $3.00 or even $1.00. These equities do not trade on the New York Stock Exchange or on the NASDAQ but rather through over-the-counter bulletin board or pink sheet quotation systems. Either these stocks have been de-listed (their value fell below the minimum required by the exchange), or they are issued to quickly raise capital for new businesses or businesses that have previously filed for bankruptcy. Here are some pros and cons of investing in penny stocks.
Pros of Investing in Penny Stocks
- There are some companies that issue penny stocks and are not new to the market or have a history of bankruptcy but are growing, profitable companies that have simply flown beneath the radar of investors. When discovered by mainstream investors, these stock prices can increase very rapidly, sometimes in a matter of days, thereby profiting the buyers.
- These stocks are very cheap, so a large quantity can be bought for little money. For example, if a stock trades at 25¢/share, one can buy 1000 shares for $250.00.
Cons of Investing in Penny Stocks
- These companies are not required to file with the Securities and Exchange Commission so they are not scrutinized by the public or regulated by any third party. When information is available, it often comes from disreputable or biased sources. Indeed, it is common practice to pay individuals to recommend a certain company’s stock in press releases or the media.
- These companies do not meet the minimum standards set forth by the major stock exchanges and may have been de-listed. This makes investing in them inherently riskier than investing in listed companies that do meet these standards.
- These companies are either newly formed or near bankruptcy; either they have no track record or a very poor one. In both cases, it makes little sense to invest in such companies unless the situation is truly extraordinary or the investor is a short-term trader looking to capitalize on market fluctuations. The hope that one will happen upon a new Walmart or other company on the verge of making it big is usually unfounded as few reputable companies started out that way. Even in its beginning, Walmart’s shares were valued at more than $5.00.
- Beware of penny stock scams! These stocks, being minimally regulated and tending to fly under the radar, see lots of fraudulent price manipulations (pump and dump schemes) from shady operators who pass the stocks back and forth between themselves to rise prices then pass the stock on to unsuspecting buyers.
N. Boutamine | The Edge Blog