There are several accusations about penny stocks that can make an investor hesitant and timid to invest because of a “risky no-gainer gamble” stereotype. These statements are exaggerated and erroneous…

Learning the truth about what you heard in the past…might be a wealthy opportunity for the future…

Here is the top three…

Misconception #1: Penny stocks are priced low because they are poor performing companies.

Penny stocks are usually small and newly created companies. While still trying to get established, penny stocks are analogically infants and toddlers compared to large-cap adult companies. With great parental guidance from a superb managing team, penny stocks can hold a promising future.

Hints: Do your research! Get background information. There may not be an abundance of information on the company because of lack of media attention. So research patiently and vigilantly.

Check if the managing executives and board members are respectable and passionate towards the company. A positive staff is always going to produce great work and show that through the company’s bottom line.

Make sure the company is in a growth position and if they are compatible with future trends and markets. A company’s willingness and desire to expand is a good indication of the value of a company to potentially rise.

Another good way to analyze a company is by reviewing a company’s financial reports and accounting sheets. 10-K annual reports are a great source to attain information. Comparing and analyzing numbers throughout the years will show the “guts” of a company that you won’t read or hear about in the news. However this process can be challenging…

In compliance with SEC rules, companies have to report their financial records. Inside executives know that these records are easily accessible and can show the value and worth of the company. As a loophole, firms will try format the reports differently every year to make the evaluation more difficult and tedious to analyze.

Misconception #2: Penny stocks are all frauds.

Some investors have fallen victim to the “pump and dump” scheme — a system where spammers will buy a stock and then hype it up by sending out positive e-mails and internet ads causing the price of the stock to jump. While the price is up, spammers will sell at a net gain, causing the price to fall, leaving their victimized investors holding the bag.

Hints: Go back to the basics. One of the primary rules to investing…never…ever…invest on tips and rumors. Chances are, your source is wrong or you’ll get in too late…

Do your research! Make sure you know what you are investing in. Make sure your sources are honest and ethical and act upon the interests of its investors and clients. Tips are only ideas. Investments should only be made on your own personal conclusions.

Misconception #3: Penny stocks will usually generate a net loss.

Every stock bares risk. Whether they are priced from $0.01 to $1,000, or a microcap or a large-cap company. Barriers to entry and competition are high these days… Since a majority of penny stocks are young and small companies, its common for penny stocks to default under a competitive market.

In fact, penny stocks are one of the fastest and easiest ways to make double or even triple your money.  It’s a whole lot easier for a $2 stock to jump to $4 than a $60 to $120.

Hints: Do your research! Are you starting to see a pattern here? Make sure the industry sector of the company is compatible for future market trends. Analyze the company by generating different scenarios. For example… Would the company be affected by high oil prices? Is their innovative product going to be the high in demand? How would they perform in a recession?

Generally, the more risk you have, the higher the yields can be. If you enjoy risk and want to make big-time returns, by all means go ahead and invest irrationally. But if you are risk-adverse, go back to the basics and diversify your portfolio.

There you have it, three truths to investing…

These common misconceptions are the response to investor’s bitterness of poorly managed securities. For what it’s worth, that’s up to you. But with sufficient research and a promising future market, penny stocks can yield gains far greater than you could have imagined…

Regards,
Mark Louie
August 11, 2008

Beware of Penny Stock Misconceptions was originally featured in the Penny Sleuth.