Q. I've heard a lot about penny stocks but am not sure what they are. Do they really cost a penny? Are they a good idea for someone who doesn't have a lot of money to invest?
A. In the days of yore, they often did cost only a penny per share. Today, any stock selling for under $5 or so per share might be considered a penny stock. They often represent companies with less-than-stellar track records, promising great success around the corner. (Revolutionary gold deposit detectors! A cure for the common cold!)
Penny stocks are dangerous because people think low prices mean bargains -- that they'd be better off spending their $500 on 300 shares of a penny stock than on 20 shares of, say, McDonald's (NYSE: MCD).
It can be hard to believe, but a stock might be grossly overvalued at $1.50 per share but significantly undervalued at $150 per share. Many people don't understand this, and they often gravitate toward the $1.50 stock, thinking it'll more quickly double in value. That's a risky assumption, though.
Most penny stocks are selling for a low price for a reason. Their businesses are often in trouble, or were not worth much to begin with. Penny stocks are also more vulnerable to stock-price manipulation. They occasionally get hyped and soar briefly, before plummeting back to earth.
Occasionally, potentially good investments slip into penny-stock land, only to rebound later. Here's one yardstick to use: If the stock is still listed on the New York Stock Exchange or the Nasdaq, then it still might be worth investigating. However, if the stock has been delisted and relegated to over-the-counter status, then you can assume the company is in dire straights. In other words, avoid that penny stock!
If you don't have large sums to invest, don't despair! Check out our article on how to invest $20, $100, or more.
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This question and answer is adapted from The Motley Fool Money Guide: Answers to Your Questions About Saving, Spending and Investing. For answers to this and 499 other common money questions, check it out -- it's a handy resource.
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