The allure of penny stocks can be strong, especially to new investors. They seem affordable. They seemed poised for monster growth — after all, if shares just jump from a dime to a quarter, I’m rich, right? And ads across the internet tout the massive, short-term returns, usually accompanied by a picture of a fabulously rich guy enjoying his newfound wealth.
As a result, one of the most common questions we get from new investors is, Should I buy penny stocks?
The short answer is, no way. More often than not, penny stocks represent the opportunity for other people to get rich … by taking advantage of you.
The problem is that in general, there’s a tendency to confuse price with value — just because a stock might cost less than what you have in your jeans pocket doesn’t mean you’re not overpaying for it.
The truth is that penny stocks are inherently dangerous. As Fool writer Jordan Wathen described it, they’re “a cesspool of failed companies, frauds, and schemes intended to transfer money from the greedy newbie to their motivated, if unsavory, operators.”
Over-the-counter stocks are generally less liquid, and they have fewer requirements to remain listed. Many don’t even bother to file financial reports on time, or at all. And they’re often managed by people with a less-than-stellar pedigree.
Conflicts of interest are especially common. As Wathen wrote, “I’ve seen it all — from company-owned planes that are used more for the executives’ pleasure than business, to companies that pay above-market rents because the CEO just so happens to also be the landlord.”
Here at The Motley Fool, we consistently recommend avoiding penny stocks (here’s a great article that walks you through exactly how these scams play out). Though they may seem like an easy and simple way to quick profits, know that penny stocks are anything but. The “easy” way to get rich in stocks is to buy good businesses and own them for a very, very long time — years, if not decades.
As long-term investors, we believe in investing in great companies that we expect will increase in value over time. We’d rather own one share of a company we love than 100 shares of one we know nothing about or, worse, one that will be bankrupt by this time next year.
If you’d like to find some of the companies that will help build your lasting wealth, we invite you to take a look at Stock Advisor, our flagship newsletter service.