There are few riskier investments in equities than penny stocks. These companies, which trade for less than $5 per share, are often priced that cheap for a reason. A penny stock, for example, might belong to a once-thriving corporation that is now on the verge of bankruptcy or has had to de-list from bigger exchanges and is now trading over-the-counter (OTC).It might also be a new firm with little market experience that has yet to meet the standards for listing on a major exchange.
Penny stocks are inherently volatile and dangerous, and they are particularly vulnerable to price manipulation. However, every now and again, a penny stock may richly reward the risk-taking investor. If you acquired Monster Beverage Corporation (MNST) shares in 1996 when they were $.04 a share, you would be a happy investment today: Monster traded over $66 in 2020.
If the prospect of such exponential returns piques your interest, it may be worthwhile to wade into the murky waters of penny stocks.
- Penny stocks are low-value shares that often trade over-the-counter since they do not fulfill the exchange’s minimal listing standards.
- Penny stocks may be considerably riskier than listed equities and can be manipulated.
- Some penny stocks, on the other hand, may be diamonds in the rough with unrivaled profit potential.
Check the Fundamentals
Before investing in a penny stock, investors should perform extensive research. Investing in the failing Walter Energy Co., for example, may have seemed to be a solid option. Walter Energy, after all, had reached a high of $143.76 per share in 2011. Those who purchased Walter Energy for $0.16 would have been burnt since the firm shortly entered bankruptcy. An investment in Inovio Inc. (INO), which was trading around $1 in 2008, provided investors with many chances to exit over $10 in 2009 and 2013 through 2020.
The sharp difference between these two equities is based on corporate fundamentals. Walter was a well-established corporation in the metallurgical coal industry, an elderly industry subject to cyclical demand and political pressures. When world leaders pledged to reduce greenhouse gas emissions, it added to the downward pressure on Walter Energy, which was already dealing with a global coal supply glut and weakening Chinese demand. In 2016, Walter sold its assets to two entities.
Inovio, on the other hand, is a speculative biotechnology play with solid collaborations in its cancer vaccine portfolio that has great takeover potential. A takeover has not occurred as of 2020, yet the stock continues to fall and then experience big upward surges that rapidly fade.
When evaluating penny stocks, you should carefully compare any prospective profits against the company’s basic considerations, such as debt, cash flow, takeover possibilities, and Porter’s Five Forces of Competition, among others. Before you even consider purchasing the stock, you need have a clear understanding of why it is trading at its present price.
When contemplating purchasing penny stocks, fundamental research and due diligence of the company’s management quality, as with any stock acquisition, may assist lead to the winners and avoid the losers.
Industry Life-Cycle Analysis
In addition to studying a company’s financial sheet, penny stock traders should do an industry life-cycle analysis. Some penny stock businesses operate in an industry that is still in its “pioneering phase.” The existence of a high number of small-sized rivals in the area, innovative goods and ideas, and low client demand define this first period. Because this time is characterized by a flood of start-up enterprises (especially in technology or biotech), all of which have significant expenses and little-to-no revenues to date, the majority of these companies will trade at very low prices due to their speculative nature.
Following this first phase comes the “growth phase,” in which many of these enterprises get more market attention, resulting in increased sales and demand.
The late-1990s tech boom (and meltdown) is a prime illustration. Many IT businesses began as penny stocks and subsequently enjoyed spectacular rises in market capitalizations and values as investors swooped up everything linked to the then-novel notion of the Internet.
Penny Stock Industries
Unsurprisingly, industries that provide binary outcomes for the majority of their enterprises will have a multitude of penny stocks. Binary outcomes, often known as “make or break” speculative bets, are most common in the biotech and resource industries.
Many resource-based penny stocks that took off during the commodities boom of the 2000s were traded on the Canadian TSX Venture Exchange. Then the celebration ended, and most of the equities sank to zero, just as many technology firms did in the 2000 crisis.
However, when circumstances are good, such as when commodities are growing, traders may still take advantage of binary-type enterprises. However, investors in these sectors must be aware that stocks may fall just as rapidly as they can gain.
It’s all about “location, location, location” in real estate.” It’s all about “management, management, management” when it comes to penny stocks.” A strong management team may turn around a troubled company or propel a startup to new heights. More significantly, skilled and ethical management with a stake in the firm via share ownership may offer investors with reassurance.
Of course, superstar executives are seldom found working for penny stock businesses, but there are a few exceptions. Consider Concur Technologies, which recovered from its post-tech bubble price of $0.31 and was acquired in 2014 for $129 per share. Many elements contributed to this extraordinary turnaround, but one that stood out was President and COO Rajeev Singh’s keen involvement. Singh, who co-founded the business in 1993, had a variety of executive positions throughout the company’s history until ultimately stepping down after Concur’s purchase by software behemoth SAP SE (SAP).
The Bottom Line
Penny stocks are notoriously volatile and speculative. Penny stocks are vulnerable to manipulation and fraud because they trade on OTC exchanges or through pink sheets, where listing criteria are inadequate. Nonetheless, the possibility for big profits is a great enticement, luring risk-taking investors to engage in these instruments. Despite the fact that many penny businesses fail, if an investor does extensive fundamental research and selects competent management teams, they may unearth the sought diamond in the rough.
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