Why We Love Wild Penny Stocks … in a Recession

Even the nihilists out there (anyone?) will be disheartened by this: A new nationwide survey finds that "top economists expect the already deep recession to get even worse this year."

That bad news, coming during a bear market that's decimated just about every stock investor's portfolio, can only mean one thing.

It's time for penny stocks
Stocks were down some 40% in 2008 and are down an additional 7% to start '09, so we can think of only one move to make right now. Buy penny stocks.

That's right, those tiny, low-priced lottery tickets have tremendous upside potential. They're our only shot to make up 2008's losses … fast!

Who's with us?
After all, why would anyone want to buy $160 billion Procter & Gamble (NYSE: PG  ) when they could own a significant stake in the upside potential of $50 million Spectrum Pharmaceuticals (Nasdaq: SPPI  ) and its portfolio of potential cancer blockbusters?

C'mon! The best we'll get out of Procter & Gamble is 8% to 10% annual growth, some share repurchases, and a dividend. But Spectrum? Whoa! If it "solves" cancer, we'll be filthy rich!

Sarcasm alert
Alas, this is not investing. And if you thought we were serious about penny stocks, please check out an old anti-pennies rant of ours, "Why We Love Wild Penny Stocks."

See, investing in penny stocks is speculating, not investing. Vanguard founder Jack Bogle, in remarks here at Fool HQ in December, said that a single question will separate the wheat from the chaff: Are you an investor, or are you a speculator?

Speculating -- at all, but especially in penny stocks -- is not investing, now or ever. Indeed, Proctor & Gamble will preserve your capital and earn you a healthy return. Spectrum has the potential to go up, but it also might go to $0. Unless you're an expert in analyzing their science, we'd advise you to stay away.

The story behind our headline
Advising folks to avoid penny stocks may seem obvious, but in fact, many "investors" are looking to buy up wild penny stocks precisely to make up for the losses they may have endured last year.

And this isn't particularly unusual. A forthcoming research paper by Alok Kumar of the University of Texas showed that "individual investors' demand for lottery-type stocks increases when economic conditions worsen."

Several years back, economists Richard Thaler and Eric Johnson speculated that there may exist a "break-even effect," where, given past losses, people are faster to turn to outcomes that offer a chance to break even. And it would make sense in today's market.

After all, the market lost nearly 40% in 2008, and over 7% thus far in 2009. Shareholders of once-proud blue chips like General Electric (NYSE: GE  ) , Xerox (NYSE: XRX  ) , and Bank of America (NYSE: BAC  ) lost 50% or more last year. Even the highflying, seemingly unstoppable duo of Apple (Nasdaq: AAPL  ) and Google (Nasdaq: GOOG  ) were cut in half last year! Calling today a "great buying opportunity" is little consolation to shareholders of those businesses (even if we believe that to be a true statement).

Of course, the flight to "lottery-type stocks" would be a fabulous development … if these stocks delivered lottery-type rewards. But if you've ever played the lottery, you know that you're way more likely to lose for the rest of your life than you are to win -- even just once.

And so it goes with penny stocks. Professor Kumar found that folks who buy penny stocks earn at least 4% lower average returns -- every year -- than those who don't.

Where to from here
In a column we wrote last year, we excerpted an insightful Richard Russell essay that compared an investor who had ample funds and an investor who was more desperate:

This fellow always feels pressured to "make money." And in return, he's always pressuring the market to "do something" for him. But sadly, the market isn't interested. When the little guy isn't buying stocks offering 1% or 2% yields, he's off to Las Vegas or Atlantic City trying to beat the house at roulette. ... And because the little guy is trying to force the market to do something, he's a guaranteed loser.

Not to put too fine a point on it, but buying wild penny stocks -- recession or expansion -- all but guarantees that you're an investing loser.

The Foolish bottom line
Penny stocks like Spectrum offer more risk, lower returns, and the potential for total capital loss. We'd advise you, then, to stray from speculating and stick with investing.

But if it is room to run and wide market opportunities you're after, we'd advise you to look at international stocks. As co-advisor of our Motley Fool Global Gains service (Tim) and a contributing author to the international investing chapter of our most recent book (Brian), we believe the growth potential of many foreign stocks -- even some of the stalwarts -- could lead to multibagger returns at today's prices.

Right now, we're offering a full-privileges tour of Global Gains free for 30 days. Come tour the service and get our team's top five foreign stocks for right now, by just clicking here.

Tim Hanson is co-advisor of Global Gains and does not own shares of any company mentioned. Brian Richards is assistant to the regional manager, Dunder Mifflin Scranton, and does not own any companies mentioned. Google is a Motley Fool Rule Breakers selection. Apple is a Stock Advisor pick. Bank of America is a former Income Investor choice. The Fool owns shares of Procter & Gamble. The Motley Fool is investors writing for investors.


Read/Post Comments (40) | Recommend This Article (130)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 05, 2009, at 4:19 PM, mberan wrote:

    Then why do one of the regular writers on The Fool keep touting SIRI, which is now a penny stock?

  • Report this Comment On February 05, 2009, at 4:43 PM, em5942 wrote:

    In this present environment I need something new and positive to restore life to my portfolio. My current advisors are not making it. I look forward to hearing more from Motley fools.

    Elizabeth Moore

  • Report this Comment On February 05, 2009, at 4:49 PM, hawkeyechet wrote:

    define penny stock, here's mine, (penny stock). purchased 521000 shares of "EESO" in june, at or around .0011, that's a penny stock. today 2/5/09, it's worth .0215, still a penny stock. nm, at 4.20, to me , is not a penny stock!

  • Report this Comment On February 05, 2009, at 6:36 PM, bobofkew wrote:

    By the standards of yesteryear GM, Ford, Citi and quite a few others fall into the penny stock category.

    Watch this space!

  • Report this Comment On February 05, 2009, at 6:45 PM, TMFDiogenes wrote:

    Regarding the definition of a penny stock, the previous column, Why We Love Wild Penny Stocks gives the SEC's definition:

    According to the Securities and Exchange Commission, the term "penny stock" generally refers to low-priced (below $5), speculative securities of very small companies. To quote the SEC: "Investors in penny stocks should be prepared for the possibility that they may lose their whole investment." (It's worth noting that the emphasis in that last sentence is in the original.) Pay attention to the SEC's entire definition, not just the stock price.

    http://www.fool.com/investing/small-cap/2008/02/13/why-we-lo...

  • Report this Comment On February 05, 2009, at 6:47 PM, footchester wrote:

    "When the little guy isn't buying stocks offering 1% or 2% yields, he's off to Las Vegas...."

    Am I reading this incorrectly, or is the author implying that there is something wrong with buying stocks that pay modest dividends? What was his point?

  • Report this Comment On February 06, 2009, at 1:37 AM, Narcoticsrus wrote:

    " Hey guys!! Mberan you are on to something! I think that most of you will find an article on the bulletin boards by an author Narcoticsrus. It's called " The Penny Stock Reality". Everyone should read it.

    Steve

    aka Narcoticsrus

  • Report this Comment On February 06, 2009, at 4:07 AM, madmilker wrote:

    i luv them too....tats why i put $1.97 into VALCENT PRODUCTS......

  • Report this Comment On February 06, 2009, at 7:51 AM, Meatros wrote:

    I like XOHO.OB, as a pennystock. It's hovering in the .10-20 cent range and it looks like the telecom industry is going to explode in the next few years.

  • Report this Comment On February 06, 2009, at 3:48 PM, ziq wrote:

    You mean those email alerts I keep getting are wrong?? One of them *has* to hit it big!

    (Sarcasm alert still in effect, right?)

  • Report this Comment On February 06, 2009, at 6:36 PM, socalclint wrote:

    I watched a 'penny stock' for years before buying. MEMY (Memory Pharmaceuticals). I bought @ .09 after their 3rd or 4th product went into clinical trials & Roche paid the bills. MEMY has never made a dime. But it only made sense that eventually Roche would have to buy the company. Sure enough, less than 2 months later Roche bought the company for .61 per share. So, for me (and only after a lot of research), my penny stock is the only thing that offset ALL of the losses on my 'they're too big to fail stocks'. PLUS since many well respected stocks are now considered penny stocks, I believe this time that many penny stocks really do have the potential to make lot of money in a short time. I'm looking forward to a big increase, eventually, Best of luck to you all!

  • Report this Comment On February 07, 2009, at 6:04 PM, steven107 wrote:

    I'm bad luck, keep that in mind, but I'm betting Spectrum does continue to exist into 2010, and that it's price appreciates more quickly than PG. In addition to that, there is another Penny Stock of similar size that I believe will do well over the same time period. Like I said, I tend to do poorly; it is what I do well at.

  • Report this Comment On February 13, 2009, at 12:11 PM, fibreoptik wrote:

    yeah ziq, one of those 4000 e-mail alerts has to hit it big eventually ;) lol

  • Report this Comment On February 13, 2009, at 2:56 PM, Langalier wrote:

    Every once in a while someone does build a better mousetrap.

    The trick is to recognize one, when they do.

    Lang.

  • Report this Comment On February 13, 2009, at 3:36 PM, missbaysdaddy wrote:

    Several years back I invested in REIT stocks that were all above the $10.00 per share price line some of them as much as $20.00 and today with the exception of one all are penny stocks and no longer paying the 6 to 8 percent dividend that I bought them for. I have lost so much in them that there is no point in selling what is left unless I get rich and really need a tax write off and the way things are going I am not betting on that either. Now I am buying some of the stocks that the Motley Fool is recommending and hope they do better than I did on my own. Fool on.

  • Report this Comment On February 13, 2009, at 3:50 PM, emkFOOL wrote:

    Depends what you are looking for. I bought a boatload of SIRI yesterday at .07, sold it today at .11 and made a boatload of money. Do I think Sirius is a sustainable long term business that I would hold? Definitely not. With that said, most of the short term momentum in the market, especially these days, is speculation. Nothing wrong with watching it, tracking it, and capitalizing on it, if you have money you can afford to lose.

  • Report this Comment On February 13, 2009, at 4:12 PM, Dart65GTConv wrote:

    Here's some more. MELA hit for 70% today more for me bought it in low 3s, also check XDSL, and up 40% on PGOG and grabbed up on a a few thou of LEMHQ at .04. MELA saved my week today amen. Love pennies they seem to move agsinst the market sometimes.

  • Report this Comment On February 13, 2009, at 4:49 PM, Momentummonkey wrote:

    When most people think of penny stocks, they mean story stocks with no earnings and sometimes scant revenue. Those are definitely to be avoided. OTOH, sometimes you stumble on an unknown micro-cap with fast growing revenue, earnings, cash flow, the ability to attain funding without dilution, straightforward manangement, organic growth AND growth thru acquisitions. And after you've convinced yourself that it's a real business with brilliant prospects, you start buying shares. When it drops you buy more, and then it drops again, and you realize there is simply no market for the shares because nobody is even looking at it. Eventually, it may take off, but you can wait a long long time.

    Case in point; GLOB.OB There is absolutely nothing wrong with this company except the share price. Especially if your average cost is over a dollar.

  • Report this Comment On February 13, 2009, at 5:05 PM, Dart65GTConv wrote:

    MELA it seems should have a supreme demands. Also assuming they achieve FDA approval for Melafind units they will retain the diagnostic business for themselves. Nice long term income.

  • Report this Comment On February 13, 2009, at 5:36 PM, ShaguntalaDevi wrote:

    I am going to disagree with the author. I have been investing in Penny stocks for some time.

    It is true that some will cause you to lose your investment.......BUT there are many that will really give you high gains.

    I am in BBDA.PK right now. It is a PINKSHEET stock. They are in the process of manufacturing a energy drink that will contain enzymes. THERE IS NOTHING LIKE THAT IN THE MARKET RIGHT NOW.

    They already are distributing spring water and are also sponsoring a mixed martial arts fight that is coming up Saturday Feb. 21st. HUGE POTENTIAL.

    There are always some good investments in the PINKSHEETS.....but it is up to the investor to find them.

    Good Luck To All Investors. God Bless.

  • Report this Comment On February 13, 2009, at 7:58 PM, fayoda wrote:

    I think most of you who commented missed the point. Penny stocks are an almost guaranteed loss. Both in the short term and in the long term.

    Reason?

    Short term - these stocks trade over the counter. There is not an efficient market for them. i.e. there is no specialist to provide a market for these securities so you pretty much have to find you own buyer. Over the counter brokers that will help you trade these stocks have what is called a BID/ASK price. In laymen's terms, the bid price is what you can sell the stock for, and the ask is what you can buy it for. usually, in percentage terms this can be quite high. e.g. bid at .04 and ask at .12. You can see the problem. You can buy at .12 but can only sell at .04. The only way to make money in this situation is the hope that enough people will want this stock that will cause the bid price to increase over 300%. Good luck there.

    Long term - these stocks are trading for pennies because they are either poorly run or lag in their market sector. In the long run, they will probably decrease futher in value and eventually fold. End of story.

    Sometimes you get a break, like the few who commented, but you odds of continuing to make money this way is pretty low.

    fy

  • Report this Comment On February 14, 2009, at 10:41 AM, tommybitt wrote:

    I agree with Fayoda...

    Don't invest money you can't afford to lose.

    If you need to speculate, don't "use" more than 10% of your overall portfolio.

    Or you may as well just go to AC or Vegas.

    (actually your odds may be better there.)

  • Report this Comment On February 14, 2009, at 9:22 PM, philipophx wrote:

    Pureplaymusic (PPML) is headed for very big use in the entertainment field. Very few shares available. Anticipating over 500,000,000 in revenue. Check out web page.

  • Report this Comment On February 16, 2009, at 8:34 PM, gerardkempf wrote:

    Ummm - I think that it's safe to say a bank stock I bought at 10 that is now hovering above 1 with no dividend is any different than 50,000 shares of Purespectrum (PSPM) at 0.02 that's now .42, is in the green energy space and has patents is somehow a farce? Hmm - my gain being purely speculation when a bunch of paid-off analysts recommended holding the bank stocks til after it was too late. Give me a break. One should do their own homework and if it passes the smell test then I say go for it.

  • Report this Comment On February 18, 2009, at 10:45 PM, gerardkempf wrote:

    Yes it's such a shame that as of close on 18th this penny stock jumped again in 3 days to close at .68 up from .42 There are diamonds in the rough when DD is done. Hoping to get it up to $1.00 then my 50,000 shares bought at .02 selling for $1 wouldn't look to shabby huh? Check out PSPM

  • Report this Comment On February 24, 2009, at 2:51 AM, steven107 wrote:

    I don't believe a company needs to be well known to be a good purchase. I've read many a Fool article that says to look for unknown stocks.

    A stock price also, for the most part, is irrelevant to purchasing decisions; and says nothing about a companies size or prospects. There are million dollar companies with 10$ stocks, and multibillion dollar companies with 1$ stocks, especially since 2008.

    Whether Berkshire leaves its stock unsplit at 70,000 per share or does the extreme opposite and set it to split annually at a ratio that holds the stock at 1$; the Cap would go up and down and the company's prospects would remain unchanged and the share price would tell you nothing about the company.

    I'm hardly the purchaser of wize stocks; heck I lost quite a bit of money in AIB. Read at least 5 different market experts in addition to a number of Fools that touted it as a wize investment, agreed with the arguments, but wasn't smart enough in the field of economics to see the inevitable decline.

    If you do find a good company, its what's on the inside that counts, not necessarily the, flashy brand name, and lots of coverage by analysts, and being a multibillion dollar large cap.

    It's probably more important that it is an industry that you understand. Thats the most important thing I've taken from The Fool, and WB.

    I will probably lose money in Spectrum as the Author states above, but I understand it's business better by quite a margin more than I understand Apple, P&G, or AIB. I lost more in AIB, more quickly than I have lost money in any stock I have ever purchased. Don't give 'experts' more credit than you give yourself.

  • Report this Comment On February 24, 2009, at 2:59 AM, steven107 wrote:

    I made a mistake above, I meant if Berkshire held it's stock at 1$ through a special annual split mechanism purely for funny reasons, the overall amount of shares would go up and down; not the Cap. I just meant the Companies Growth will be recognizable through its Cap, not it's share price; and if that is what suits your fancy, that is where you need to be looking.

  • Report this Comment On March 10, 2009, at 4:05 PM, ackland18 wrote:

    Despite the economic troubles I have still be making decent gains of 10% a day usually. I follow this company called iron hot stocks and they have a pretty big following it seems. The stocks they usually pick go up 50-100% in a week, but I play it safe. You guys should check out I'm a huge fan.

    here is the link:

    http://www.ironhotstocks.com

  • Report this Comment On April 16, 2009, at 10:29 AM, dogpuke wrote:

    I remember reading somewhere that 99% of penny stocks fail. I have little reason to doubt this. However, every once in a while one does hit and they can be enormously profitable. For example, look at PSPM. I've made over 300% so far this year with this stock. Am I speculating or investing? A little of both. I did a lot of DD on this stock and liked their technology which is clever, timely, and potentially very lucrative. So I'm invested for the long haul with these guys. Call it a speculative investment.

    Do the math: 160M shares, expecting $100M revenue for 2009 @ 35% sales margin. I bought in at 0.14.

    Yep, there's some risk here. But ask those who held AIG, FNM, or GM how their 'safe' stocks are doing.

  • Report this Comment On May 17, 2009, at 9:56 AM, tedarjack wrote:

    What about copper king mining cprk. I've yet to see anything about this company on this site.

  • Report this Comment On May 24, 2009, at 11:57 PM, projectchris wrote:

    Interesting you pick this stock to write about. Speculative, yes, but the science is definitely there for Zevalin. Talking with fellow colleagues, RIT Zevalin has been a very valuable tool in the treatment of NHL.(Improvement in patients lives from clinical followup) Hopefully Zevalin will finally be used in a bigger population size, and get due respect it deserves. Many challenges here, but am confident challenges can be met.

  • Report this Comment On June 01, 2009, at 10:54 PM, VerySharp wrote:

    Here is a tip on penny stocks:

    BBDA

    http://www.bebidabeverages.com/index.html

    it is $.0004

    Think $1.00

  • Report this Comment On June 01, 2009, at 10:55 PM, VerySharp wrote:

    BBDA

    @ .0004

    Think $1.00

  • Report this Comment On June 04, 2009, at 10:18 AM, ftara wrote:

    doubt that bbda will ever even hit 10 cents

  • Report this Comment On June 30, 2009, at 12:45 PM, steven107 wrote:

    SPPI Feb 5, 2009: 1.47

    SPPI June 30, 2009: 7.72 (12:53EST)

  • Report this Comment On July 20, 2009, at 7:50 AM, projectchris wrote:

    Not declaring victory or anything, but with over $100 million in the bank, and burn going down. I don't think we are going to see $1.47 anytime soon. Add in a couple label expansions on 2 already approved drugs, and I would think the possibility of getting in at $1.47 again is wishful thinking. Not that it couldn't go down significantly from current $5.50 price. I think management a lot better than some seem to think.

  • Report this Comment On August 04, 2009, at 7:52 PM, steven107 wrote:

    I agree, 1.47 is the price on the date the article was written, poopooing Spectrum as a legitimate investment. I realize that there are not going to be any more good opportunities to get in cheap except for right after the recent delay, though that was shortlived, it has already climbed back into the 7's.

    The author(s) likely chose it at random, without doing any research, this article has since been reused many more times with more random small or microcaps vs largecaps.

    I especially like the tone where they suggest that if you are a small or microcap investor that you are not an investor but a speculator.

  • Report this Comment On August 04, 2009, at 8:01 PM, steven107 wrote:

    '...I think management a lot better than some seem to think...'

    He is smart and opportunistic, which are good traits when he is using them on behalf of the company; but are negative traits when he is negotiating his pay and stock options, in which specific case I'd rather he were humble and naive.

    He is also good at keeping expenses in check and not issuing stock to raise company funds when the company stock is cheap (he doesn't seem to have the same regard concerning his pay and his options perhaps he doesn't consider them expenses, my opinion). Some have complained that he has diluted recently; but i'd have hit him over the head if he hadn't taken the opportunity to raise funds at these stock prices.

  • Report this Comment On November 12, 2009, at 2:37 PM, glenhoover wrote:

    I did not see whether there was anyone responded to the quote in May about Copper King Mining (cprk). I am a shareholder in this stock and have seen ups and downs. The processing of the ore has finally begun. It may be time to load up on this again while it is still low.

  • Report this Comment On February 16, 2014, at 8:20 AM, BadExample wrote:

    Um, Spectrum Pharmaceuticals has a market cap of $500,000 million today. Thats 10x gain in 5 years. If you managed to sell in 2012 it was almost a 20x gain from the date this article was written.

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