Why We Love Wild Penny Stocks

Penny stocks have huge potential -- that's their blessing and their curse.

The potential rewards are enormous. Just take a look at the returns from Avistar Communications (Nasdaq: AVSR  ) and Emvelco (Nasdaq: EMVL  ) , which have each more than doubled since the beginning of the year. Neither traded for more than $1 per share when 2008 started.

Those $1 doubles look like easy gains, considering that Whirlpool (NYSE: WHR  ) would have to add another $91 in value to double its share price, and Washington Post (NYSE: WPO  ) would need to throw another $747 on the fire to eke out another double.

Everybody loves pennies
It's the potential of quick gains in "cheap" stocks that keeps investors coming back. We typed "penny stocks" into Google, and the search engine spat out "about 3,750,000" hits. We did the same for more time-tested terms such as "blue-chip stocks" and "dividend-paying stocks" and got just 228,000 and 496,000 hits, respectively.

Sure, we expected a discrepancy, but the size of the gap was startling. It became even more interesting when we broke down those hits with Google Trends. According to Trends, penny stocks are particularly alluring to investors in Las Vegas, Tampa, and Orlando -- the locales where the term is most often searched.

Las Vegas, for one, makes a bit of sense. Those folks are gamblers.

Florida, though? Well, we hope the folks Googling "penny stocks" down there aren't retirees.

This stock is set to take off! Or not.
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. Going solely on price would wrongly categorize billion-dollar companies such as Atmel (Nasdaq: ATML  ) , 3Com (Nasdaq: COMS  ) , and Aquila (NYSE: ILA  ) as penny stocks.

Regardless, the SEC is spot-on when it says that true penny stocks are among the surest ways to lose money in the stock market.

Well, then, why do we love penny stocks?
We love penny stocks because they're fascinating. The world of pennies is inhabited by hardworking average Joes hoping to strike it rich, as well as by pumpers and dumpers, hypesters and scammers. In pennies, the logic and reason that applies in the rest of daily life is replaced by zeal and prayer.

However, we don't love them enough to actually buy them. Yes, they have big potential. But their daily gyrations are unpredictable -- the stock-price movements have next to nothing to do with the underlying company the stock represents. In fact, trading in pennies is highly illiquid, and prices are often manipulated by forces not at all related to the business.

The dangers of incredible promises
If you're buying stocks without paying attention to the business you're buying, then you might as well be buying a lottery ticket. Or, to use another analogy, you might as well buy up every baseball card of a benchwarmer on the Akron Aeros AA baseball team and hope that he someday rises up, fulfills his potential, and becomes an all-star for the big-league Cleveland Indians.

There's a better way
Before you start saying the rest of the stock market is boring -- with big stocks such as IBM having a "big day" when they move up 1% or so -- let us introduce you to some underfollowed small caps. They're nothing like penny stocks, yet they still offer some of the best returns on the market. Unlike penny stocks, promising small caps:

  • File reliable financial statements.
  • Are transparent.
  • Have conference calls that individual investors can listen to.
  • Don't simply hype their stock in press releases.

That's a starting point. There are more -- and more important -- criteria to help you find great small-cap companies. Our team at Motley Fool Hidden Gems, for instance, looks for a balance sheet with lots of cash and no debt, and a tenured CEO (or founder, if possible) who holds a substantial ownership stake in the business. In other words, we're looking for big returns with good old-fashioned bottom-up analysis.

You can view the more than 50 small caps our team has already found with a free 30-day trial. There's no obligation to subscribe, and we particularly recommend it for the penny-stock-o-philes reading in Vegas and Florida. You know who you are.

This article was originally published July 27, 2006. It has been updated.

Tim Hanson and Brian Richards disagree about whether the U.S. Treasury should do away with the penny. Neither owns shares of any company mentioned. The Fool's disclosure policy is finger-lickin' good.

Read/Post Comments (12) | Recommend This Article (64)

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 September 14, 2008, at 5:18 PM, manshuv wrote:

    Well, I couldn't agree more. There is just too much risk in these penny stocks to be any actual good.

  • Report this Comment On February 05, 2009, at 4:37 PM, jasoha wrote:

    I have beenfollowing Hidden gems for several months, since I became a member. One of the biggest loses I have taken in years is with AOB. I have notice more of H.G recommendations are down than up.

  • Report this Comment On April 08, 2009, at 3:08 PM, lckz46 wrote:

    There are alot of great stocks out there. Team Financial is in chapter 11 restructuring and will come out of it with a bank (TFIN.PK). It is selling for .05 cents a share. The best stock bargain out there is LJPC , a phamaceutical company that makes drugs for Lupus. Currently selling for .20 cents a share with a once 47 dollar value and a good outlook on 2009. Best stocks TFIN and LJPC . If you don't have 50 dollars to try a deal then your in worse trouble than you think.

  • Report this Comment On April 08, 2009, at 9:25 PM, DaytonFlyers wrote:

    in response to LJPC- "The accompanying financial statements have been prepared assuming that La Jolla Pharmaceutical Company will continue as a going concern. As more fully described in Note 1, La Jolla Pharmaceutical Company has incurred recurring operating losses, an accumulated deficit of $415.7 million and working capital of $3.0 million at December 31, 2008. These conditions, among others, as discussed in Note 1 to the consolidated financial statements, raise substantial doubt about La Jolla Pharmaceutical Company’s ability to continue as a going concern"- E&Y

  • Report this Comment On April 14, 2009, at 7:49 PM, lckz46 wrote:

    Those were statements as of December. They partnered up since then and got millions of operating capital. According to analysts if the sold of everything they own each sharholder will get .35 cents a share. From that perspective you can't lose. Thats today's news for LJPC.

  • Report this Comment On September 08, 2009, at 6:26 PM, anthonymallgren wrote:

    Best penny stock on the market, hands down, is TBYH. Only a Fool would claim that this company is more likely to parish rather than to return to a dollar!

    Penny investors everywhere should unite to correct this severly undervalued stock, for it is not right that such a valuation should be placed upon a company with so much intrinsic value.

  • Report this Comment On April 04, 2010, at 5:09 AM, TheDean2012 wrote:

    Penny stocks are like financial weapons of mass destruction. The odds are usually stacked against you because there are people on the other side of the trade with boatloads of shares looking to dump. If you're going to trade penny stocks I recommend studying the penny stock markets and the catalysts for price increases before pulling any triggers.

    Happy Trading,

    The Dean

  • Report this Comment On March 31, 2011, at 5:49 PM, CockSureFool wrote:

    Now I'm wondering about the Fool's recommendation to buy Eagleford Energy some time ago. I bought some for 1.77 and it's now 1.10. Have we changed our outlook?

  • Report this Comment On June 07, 2011, at 11:27 PM, MichelHerbert wrote:

    Really nice site. There is just too much risk in these penny stocks to be any actual good.

  • Report this Comment On November 30, 2011, at 7:59 AM, AimHighProfits wrote:

    Will Bank of America be the next big penny stock?

  • Report this Comment On April 16, 2012, at 4:07 PM, XMFRedRam wrote:

    For the best penny stock rec's I love you can even invest in the company itself! It's low right now but a little surge could really pull this one up!

    PS - Great article.

  • Report this Comment On August 27, 2012, at 9:52 PM, joepennies wrote:

    I agree that penny stocks ARE "fascinating!" but here's why I love them so much:

    At least I do now... I didn't always as I explain why.


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