PENNIES FROM HEAVEN?
Have you ever received an email with a subject that looks like this?
‘Unlock the Doors to STAGGERING PROFITS!’
Hot IPO: Wireless Electricity!’
A Real Chance at 500% Gains in Stocks in the Coming Years
I must get 50 emails a week with headlines like these, and get forwarded a bunch more from clients asking me if they should invest in some of the companies. Everyone is promising you the newest way to make a quick buck. One of the most popular methods of investing underlying these outlandish claims is by investing in ‘Penny Stocks’.
What Are They?
Penny stocks are usually defined as very small companies, with stock prices under $5 a share. Often times you will find these shares trading under $1, or literally trading for pennies. The headlines are enticing. Everyone wants to find the next Google, and the potential of quick riches is often overpowering for many and they fall prey to the enticing headlines. If you can buy a stock trading at 20 cents, if it only moves up another 10 cents you have a 50% return. In addition, if you have $5,000 to invest, you can buy 25,000 shares. That’s sure more interesting than buying 80 shares of JP Morgan, or some other old and stodgy company. All this sounds great and so easy. The problem is that the stock can as easily go down 10 cents, and you can lose half of your money. In fact according to the Securities and Exchange Commission (SEC), the term “penny stock” generally refers to low-priced (below $5), speculative securities of very small companies. To quote the SEC: “Investors in penny stocks should be prepared for the possibility that they may lose their whole investment.” (It’s interesting that the use of Italic font is in the original.)
What’s the Problem?
There are three major issues with investing in Penny stocks:
Little Information for the Investor
When making an investment decision it’s of utmost importance to make an informed decision. The problem with Penny stocks is that they have no reporting requirements to the regulator (SEC). Which means whatever little bit of information is available to the public (and it usually isn’t much) is unreliable. If you try and search for information on these companies there often is nothing to be found. Not an advisable way to invest.
Liquidity
There are two problems with stocks that don’t have much trading activity, or lacking liquidity; there is a very real possibility that when you decide to sell the stock you can’t because no one wants to buy it from you. In such a case you will have to lower the price that you are willing to sell it for in order for it to be attractive for someone to buy it.
Pump and Dump
This lack of liquidity is what then leaves to the infamous “Pump and Dump” scam. This occurs when some investor slowly accumulates a large amount of shares in a particular stock, and then starts pumping it up via newsletters, cold calling prospective investors, fake press releases and email blasts. They claim that it’s a very hot stock which is sure to make you a large profit. Then because there is this new demand and not many shares available in the market the price starts jumping up, and as it starts moving up, the Pumper/Dumper starts selling all the way up, and when he finishes selling, the price of the stock can fall like a ton of bricks leaving the unsuspecting investor stuck holding a bag of worthless stock.
Buyer Beware
Do NOT take the plunge into Penny stocks before doing a lot of research and make sure that you are not falling victim to a scam. If you feel that you are lacking enough information, save yourself a lot of heartache and don’t invest.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates.
Aaron Katsman is author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing (McGraw-Hill), and is a licensed financial professional both in the United States and Israel, and helps people who open investment accounts in the United States. Securities are offered through Portfolio Resources Group, Inc. (www.prginc.net). Member FINRA, SIPC, MSRB, FSI. For more information, call (02) 624-0995 visit www.aaronkatsman.com or email aaron@lighthousecapital.co.il.
