They sure come cheap with the promise of making you rich fast. And to the naïve, this often makes them the most attractive stock market investment option. But recklessly investing in penny stocks could leave you penniless. Here’s why:
They lure you by their impossibly cheap prices and greatly fuel your get-rich-quick dreams. However, should you ask the more seasoned investor about their financial viability, you might receive some very discouraging, if not shocking news. Most people who have dabbled in penny stocks have burnt their fingers and vowed never to invest in them again. So what is it that makes seasoned investors wary of penny stocks?
Financial Instability & Lack of Historical Information:
It is often seen that most companies that offer penny stocks are in the red or are on the verge of bankruptcy. Moreover, the promoters of such companies are actually looking for ways to recoup losses by any means possible. Moreover, one simply has no access to the company’s history or its performance in the past because they may have been newly formed or never researched by analysts. The stock’s potential in the long run, therefore becomes indeterminable because of the dearth of any historical information.
Some penny stocks, however, have given good returns, provided the investor has sold out at the opportune moment when the prices have risen, even at much higher expenses. On the flip side, in most cases, the company often gets delisted and the investor ends up with “dead stocks”, that cannot be converted into cash or traded at all.
Inadequate or No Financial Details Available:
The company that offers such stocks usually is stingy with providing financial details by taking advantage of the fact that markets don’t insist on proper financial documentation. There is simply no tangible information that helps the investor make an informed decision. Furthermore, it has been seen time and again that the bulk of the information on micro-cap stocks emanates from non-credible sources such as spam e-mails or articles in financial dailies or magazines where promoters of such companies actually use dubious methods to get false information across to potential investors.
Canny Operators Abound
Penny stocks, also called pink stocks, are also often subject to cons and manipulation to which the newbie and naïve investor falls prey. Canny and fly-by-night stockbrokers often advise bulk purchases with promises of considerable returns on short selling. Prices are temporarily hiked through bulk buying, only to be followed by a sudden and sharp decline which leaves the investor finally in the lurch. With low liquidity levels, selling penny stocks at the drop of a hat may pose to be a problem. One may have to lower his prices considerably for offloading even at the risk of a financial loss. Moreover, a lower liquidity level provides opportunities to certain dishonest traders who apply the pump-and-dump technique by manipulating the stock price through purchase of such stocks in bulk, jacking up prices and offloading in bulk again at attractive prices.
No Minimum Standards to Comply with
The severe lack of minimum standards in monitoring penny stocks is yet another notable disadvantage. Pink Stocks are not required to fulfill the basic standard requirements to operate on an exchange. Should the company be unable to maintain its superior position on any one major exchange, it can always move to a smaller exchange.
The thumb rule, therefore, is that one should never invest more than five percent of his capital in penny stocks, if at all. Moreover, it isn’t wise either to put all your eggs in one basket and spend only that cash that you may be prepared to shed. The experienced and wise investor, in all probability, will advise you to avoid penny stocks.