Here in Fooldom, as we try to guide you into sensible and effective investments, we can't warn people enough about the dangers of penny stocks. That's because they're just so darn appealing to the uninformed.
Imagine you have $1,000 to invest. You could buy about 13 shares of a $76 stock, such as ExxonMobil (NYSE: XOM), 55 shares of an $18 stock such as Applied Materials (Nasdaq: AMAT), or more than 7,500 shares of a $0.13 stock! Doesn't having 7,500 shares sound much better than owning 15 or 55 shares? Thought so.
The problem is that we often fail to think it through. Penny stocks are often tied to small, unproven companies with no track record of solid financial performance. Worse, these stocks are among the easiest to manipulate, and they often are manipulated by scam artists (sometimes in the form of spam e-mails). If you own 55 shares of Applied Materials, you own a chunk of a $25 billion firm that's one of the largest suppliers of equipment and services to the semiconductor industry worldwide, a company that takes in some $9 billion annually and has a net profit margin well above 15%. If you own a piece of ExxonMobil, you own a piece of American history, one that takes in about a third of a trillion dollars in revenues each year and sports a net profit margin of more than 10%.
Don't just listen to me, though. On our Investing Beginners discussion board, Fool Rob5167 asked:
I realize the risks involved with [penny stocks]. I currently have an account on Sharebuilder.com, investing x amount monthly amongst x # of stocks. I was wondering if anyone knew of a site that offered the same type of investing for penny stocks. I just want to have a little fun with this type of investing. Also, does anyone know of any free newsletters or sites that are good for advice for penny stocks?
Rob quickly got some good advice. Ramseesforever summed up the Foolish point of view very succinctly: "You'd be better off going to Vegas or [Atlantic City]."
Then SockPuppetMan noted:
Not all penny stocks are gambles. Some can actually be good investments that later become highly profitable, but it's like finding diamonds in a world of shiny rocks. Almost impossible. I agree with Ramsees, you should stay away from placing money in penny stocks....
Because Rob5167 had said he "just wanted to have a little fun with this type of investing," Dougdoogle offered a good idea: "So do it on paper instead of with cash." He then suggested that the money that would likely have been lost on the penny stocks be donated to charity.
Bbogwan said:
If you insist on this I suggest you screen for stocks with market caps less than $200 million. I don't see the fascination with share price less than $0.10 or whatever. Note that illiquid stocks have the equivalent of a front- and end-load of about 5% each. Some days you will not even be able to buy the stock, [if there are zero] shares traded.
Wcfenton pointed to places where Rob5167 could learn more, and later shared some sample portfolios. Rob then reappeared, saying, "Hey, I just wanted to say thanks to everyone who replied to my posting. Bill, I did read that article you suggested through the link, I found it interesting as I did everyone's advice to me ... I think I will stay away from this!"
Learn more fascinating stuff about penny stocks in these articles:
This article, originally written by Selena Maranjian and published on Sept. 23, 2005, was updated by Foolish research associate Katrina Chan. Katrina does not own shares in any company mentioned. The Motley Fool has a full disclosure policy.
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