Want the lowdown on penny stocks? This week, Jeffrey DeBoer, president of DeBoer Financial Group in Roseville, Calif., gives his, er, two cents' worth on investing in penny stocks and answers a trivia question on crude oil.
QUESTION: I've got a friend who's intrigued by penny stocks. He's invested in a number of tiny companies whose shares sell for next-to-nothing. As for returns, he's had some big winners and some losers. What's your take on penny stocks? Are they risky?
ANSWER: Penny stocks are stocks of public companies that trade for less than $1 per share. Typically when you purchase a penny stock, you are gambling, not investing.
To answer your question: Yes, penny stocks are risky, for a number of reasons.
Penny stocks trade on a market exchange that is mostly unregulated by the Securities and Exchange Commission. The chances of finding a legitimate penny stock are very low.
Most penny stocks are shell companies whose value goes up and down rapidly because of the individuals trading them. They can be up 200 percent one day and down 80 percent the next, though nothing occurred in the company.
Typically, penny stocks have very low daily volume. This means you could buy and own shares, but, in some cases, have no one to sell them to. You need good liquidity in a stock, especially where the stock price can tank quickly.
Penny stocks differ from most stocks in that they have little or no following by analysts. You will rarely see a stock analyst, wire house or investment bank initiate coverage on a penny stock. Unfortunately, most of the penny stock information on blogs and websites is from individuals whose opinions are based on manipulation or touting a particular stock, vs. factual analysis.
One of my greatest concerns about penny stocks is that their price is easily manipulated. Since they have such a low share price and/or very few outstanding shares, people can easily manipulate the price by placing large buy or sell orders.
A common tactic by scam artists is called a "pump and dump." They buy many shares of a penny stock at a low price and then pump up the price by sending e-mails and advertisements to unsuspecting investors about this "hot stock." The victims buy into the hype, purchasing the shares and driving up the price significantly. The scam artists then sell their shares for a large profit, leaving the victims with large losses as the stock price heads south.
