There’s a “P” word on Wall Street that should be avoided – “penny” stocks.
Penny stocks are stocks that sell for five dollars or less and, in many cases, you’re lucky if they’re worth even that much. Most penny stocks usually have no substantial income or revenue. You have a high potential for loss with penny stocks. If you have a strong urge to invest in this type of company, take time out to follow the stock to see if it has made any headway. Learn all you can about the company and don’t be tempted to act on a “hot” tip that may have been passed your way or one that you overheard in your travels.
Penny stocks trade in either “pink sheets” operated by the National Quotations Bureau or on the NASDAQ small-cap market. Pink sheets, in brief, are listings and price information literally printed on pink sheets of paper that go to select brokers.
The companies behind these stocks are thinly capitalized and are often not required to file reports with the SEC. They trade over the counter and there is a limited amount of public information available. This in itself is reason for concern. How many astute investors want to put their money into an investment offering little to no information? Nonetheless, people do invest in these stocks.
One of the most interesting—and alarming—aspects of penny stock dealing is that brokers are not always acting as a third party but are setting prices and acting as the principals in the transaction. In other words, the broker selling the stock owns large chunks of it. Penny stocks most often do not have a single price but a number of different prices at which you can purchase or sell them. Like bonds on the market, penny stocks have asking and bidding prices. Unlike bonds, you often cannot find the price listed that is being quoted to you by a penny stock dealer.
Okay, so there’s little information about the company, the price, or anything else to investigate. But the guy on the phone—making a cold call—says it will be the next Starbucks! This is where they get you. Thanks to the Internet and the selling of phone lists, penny stocks dealers can reach out far and wide. They use high-pressure sales tactics and armies of callers to tell you anything to make you buy the stocks
Typically, unscrupulous brokers hype up and promote companies that have either no assets or minimal assets. The practice called “pump and dump” is where these hard-selling wheeler-dealers hype the stocks, making outrageous claims about the company that are substantiated by absolutely nothing. They bring the price up so that they can cash in on an artificial price that is high for a company that is worth nearly nothing, or not in business at all.
Fraudulent practices by brokers could also include unauthorized trading, churning, bait and switch, and other fun methods of pulling the wool over unsuspecting new investors. Their goal is to convince naive investors that these stocks are an incredible bargain. They are so cheap you can’t pass them by. AND, when they become the next Google, you’ll be rich. Or so you think.
All of this is not to say that there are no low-priced legitimate stocks on the market. They are usually small grassroots companies that, if you pick the right one and wait a while, can grow over time. You should invest cautiously and conservatively at first. Look for a new company with good leadership in an industry where you see growth potential. It’s also advantageous to find a company that holds the patent on a new product. If the product may potentially take off, so could your stock. All of this is information you must seek out; it will not come to you via a cold caller.
All in all penny stocks are a high-risk investment, but in some instances it can payoff. Nonetheless, you should remember a few things about questionable investments in general:
1. Nothing that is a great deal needs to be hammered into you by a hard-line sales approach. No one called you on a cold call and told you to buy Intel or Yahoo. No one had to. Anything that good will sell without high-pressure tactics. In short, DO NOT BUY FROM COLD CALLS. The same holds true for the high-pressure online sales pitches of some penny stock brokers.
2. Anything worth investing money into should be easy to research and investigate. The SEC has updated information about companies registered with them. Call 1-800-SEC-0330 and ask for the form “10k,” which is the annual financial statement for a public company. Moody’s, along with Standard & Poor’s, also have information on most investments (including penny stocks), so you can look at their financial history. Moody’s and S&P are companies that provide financial information and ratings. They monitor the financial world.
3. Make sure you are dealing with a broker with a reputation you trust (get a referral). And make sure the person you’re dealing with is not someone who “specializes” in penny stocks.