Penny stocks can leave you penniless
The term 'penny stock' originated from the American stock market and was the name given to shares valued at less than one dollar.
In the South African context, there’s no definition for our low-valued listed shares.
Our version of ‘penny stocks’ are listed on the Altex exchange and that’s where these low-valued stocks trade.
Broadly speaking, I would say these are stocks of companies valued at less than R2-billion.
Why do people invest in penny stocks?
The potential of massive returns.
Penny stocks are highly speculative, which means that you are taking bigger than usual risk than say, investing in a Top40 blue chip company.
As you know, taking big risks could mean getting big rewards.
Penny stocks have the potential to double, triple and even quadruple in value if that company grows rapidly – that’s why people invest in them.
When you invest in penny stocks, what you are actually doing is searching for a gem in a scratch patch of pebbles.
If you are lucky enough to find that one, the rewards are usually spectacular.
Of course nobody knows which penny stock is going to shoot the lights out, but if you’re lucky enough to hold a stock that eventually breaks out into the ‘big time’, it’s like winning the lotto.
It’s called speculating and the belief that a certain small company is on its way to great things.
Why do people avoid penny stocks?
Ironically, the same reasons that people like about penny stocks, are the very reasons why people don’t like them.
They’re perceived as ‘risky’ and too speculative.
The problem is that hardly any analyst covers these ‘small-cap’ companies and their management.
Most analysts cover only the major companies on the stock exchange.
That means that very little is known about them and how they do business, or even how strong their cash flows are – or even how ‘honest’ their reporting is.
When it comes to trading these penny stocks, it’s often difficult to sell out of the stock.
There’s usually very little liquidity in these stocks and the gap between buyers and sellers, gets very big.
That means you will either be stuck with the shares for a long time, or be forced to sell them at a loss.
The other real danger is that a number of the smaller companies fall by the wayside and go into liquidation, or fall under administration for various reasons.
This means that your shares can end up worthless and you lose all of that investment.
Take my advice (it’s free)
There is a place for penny stocks in our market and they do form part of many investment strategies.
Be aware that losing all of your money, is just as likely as doubling it.
If you are going to invest in these small-cap shares, make sure they only represent a part of your portfolio and not the bulk of it.
Have a spread of good solid companies and a portion of small, risky potential ‘gems’.
As always, I’m more than happy to chat with my readers and answer any questions you may have, by emailing to benonicitytimes@caxton.co.za
Also read:
2017: The investors’ year of political risk
2016’s ultimate market lessons: be flexible, expect shocks, cut your losses
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