Jason is a longtime Investor and an advocate for having a personal finance strategy and personal savings to have financial freedom.
What Are Penny Stocks?
If you are familiar with investing in the stock market, you probably know something about penny stocks or perhaps have experimented with these type of stocks yourself. Companies in the penny stock category are typically startup companies or companies on the verge of failing with stock prices usually $5 or below. With this can come great risks and great rewards, depending how you treat these stocks and how you invest into them. In this article we'll go over some of the ins and outs of penny stocks, and my personal experience with being an investor of penny stocks over the last several years.
Types of Penny Stocks
As I mentioned previously, companies in the penny stock category can have many reasons why they are in this category. Some are new companies in emerging markets that have not had their day in the sun yet, some are companies that have not gained traction getting off the ground yet, and some are companies that are unfortunately on their way out.
As is expected, most companies new to the stock market typically start off in the penny stock category. Unless they already have the financing and infrastructure established, or are a well established private company going public, it most likely will mean starting off as a penny stock. With this comes a lot of patience and time investing in the company. Until their time comes, it will be an emotional roller-coaster watching the prices and the uncertainty of the company's future. With newer companies, news from the board can often times be few and far in-between, which leads to speculation as to if the company truly is achieving its goals. If you believe in the company's vision, believe in the CEO, and the company is consistently growing each earnings cycle, do not let fear or hearsay influence your investment.
Companies that have a hard time gaining ground can sometimes stay in the penny stock category for a long time. An example of this is during the initial race for the Covid vaccine in 2020, many biotech companies were competing to have the vaccine first and there was a lot of hype for nearly every company claiming to be developing the vaccine, no matter how well established of a company they were. Once the first vaccine came out, most of the hype disappeared and many companies were left with a product that was soon to not be in as high in demand in the next few years. It does not mean these were bad companies, rather just bad timing and prioritized the wrong product. This can be the case for any sector. While they may potentially have a hard road meeting their goals, it does not mean companies are failures. Continuing to develop new products, showing long-term growth, and timing these products are what they need to focus on. Companies in this category may take much longer to develop, but the potential rewards are still there.
Companies that are on the decline can also be in the penny stock category. JCPenney and Sears are two prime examples of this. Some people day trade these types of stocks thinking they can make an extra penny per share each day. This can be extremely risky, as we do not know what the future holds for companies in this category.
Pros and Cons
The biggest pros with penny stocks is they can require little capital to invest in and have potential large rewards. It is not unusual for someone to invest into a company trading for $2.00 a share and a year later, the share price grows to $60.00. This requires careful timing usually. Another is if you do have a large amount of capital on hand and are a true believer of the company, you could potentially invest enough into the company to have a say in what goes on. Since they are smaller companies, it requires smaller amounts of capital for this versus trying to become a majority shareholder in Apple for instance.
The most common con I see is the looming threat of a reverse split. What this entails is a company decreasing the amount of shares on the market in exchange for a higher price. Let's say you have 100,000 shares at $1.00 per share, and the company decides to do a 10/1 split. You will now have 10,000 shares with an average of $10 per share. Same value, but different distribution. This can be a blessing or a curse for shareholders, but often times ends up not working in the shareholders favor. I will write more on reverse splits in the stock market in a separate article.
Over the last several years, I have had an individual brokerage account solely dedicated to penny stocks, and some have been very successful while others were not. All have been startup companies or companies that have been taking a longtime getting off the ground. In 2019, I invested heavily in stocks in the EV sector, which was the perfect time to get involved just before they went to the moon a year later. Take Nio Inc (Nio) for example, in October 2019 their stock price was around $1.50, but by January 2021, their price had ballooned to $62. Many other EV companies saw a similar trend during this time. Companies that were in an emerging market and were soon to be recognized. I imagine many millionaires were made during this time. We have known for several years leading up to 2021 that eventually the EV sector would take off, and could see the writing on the wall in the making.
This is just one example of many. Companies in the biotech and tech sectors have seen a similar boom during 2019 to 2022. The key is to find which sectors work for you and believe in. Sometimes you can see the writing on the wall, like I mentioned for the EV sector. It is an industry that is emerging and while it is not recognized yet, it will be down the road.
At the same time, I have been invested in companies that I believed in, their share price plummets, then they initiate a reverse split, and my average ends up being a long uphill battle from what the new current share price is. It is the risk we take. Penny stocks can be very rewarding or they can be a financial bust. Remember to always do your research when deciding to make an investment.
So would I recommend for you to invest into penny stocks? Only if you are an experienced investor would I suggest looking into penny stocks. If you are looking for the safe and steady long-term growth in the market, you would be far better off looking into ETF's or mutual funds instead. If you are already doing that and are looking to diversify your portfolio into other sectors, exploring penny stocks may be a potential option for you. Remember penny stocks can be an emotional roller coaster and some of the companies you choose to invest in may not make it, but at the same time, some might excel. Gaining more experience in the market is a good way to help mitigate your risk of making bad investment choices.
I hope you found this article to be informative and wish you the best in your financial endeavors.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2022 Jason