In the days of yore, what we call penny stocks today often did cost only a penny per share. Today, any stock selling for less than $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! Effortless weight loss!)
Penny stocks are dangerous because people think low prices mean bargains, and that they'd be better off spending their $500 on 300 shares of a penny stock than on 15 shares of Pfizer (NYSE:PFE) or 10 shares of Citigroup (NYSE:C).
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. Your performance holding a stock really depends on 1) the stock's intrinsic value, not its trading price; 2) the price at which you buy into the stock; and 3) the amount of money you invest, not the number of shares you own.
Imagine that you buy 100 shares of a $0.60 stock and one share of a $60 stock. You'd spend $60 for each investment. If each investment doubles in value, you'll have 100 shares of a $1.20 stock, worth $120, and one share of a $120 stock, worth $120. You would have gained no advantage by buying the lower-priced stock.
Plus, most penny stocks are selling for a low price for a reason. They occasionally get hyped and soar briefly, before plummeting back to earth. Steer clear of the pennies.
Learn more about penny stocks in this follow-up article to one of our April Fool's Day jokes. You can also learn all about brokerages and find one that's right for you in our Broker Center.
