What Exactly Are “Penny Stocks?”
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Now let’s get back to the “What Exactly Are “Penny Stocks?”
“Question: 1. What are Penny Stocks?”
So just what is a Penny Stock? Even experienced equity traders may not be fully familiar, and before you invest, it’s best to have all the facts. Here we’ll provide a brief overview of the Penny Stock market and how you can become involved.
Penny Stocks by way of pure definition are simply those traded on U.S. or foreign exchanges with a market value less than $1.00 (or one unit of local currency). However, the term can be a misnomer as it often applies to stocks that are traded outside the main exchanges or have a low market capitalization with shares trading at a range of $5.00 or less—at least according to the SEC.
Penny stocks should not be confused with nano- or micro-cap stocks, who have a market capitalization less than or between $50-$300 million. Penny stocks can be, and often are, nano- or micro-caps, but nano- or micro-caps are not necessarily always penny stocks.
While these stocks can trade on major exchanges, they are often likely to be found in over-the-counter outfits such as OTCBB, and the “pink sheets.”
Why So Cheap?
When someone says “cheap” in investment language they don’t simply mean that buying a unit of stock is easy on the wallet. Cheap is really a measure of value (often measured in price-to-earning multiples), and while penny stocks are priced relatively low, they can have huge earnings potential. Stocks that trade at $.11 can ultimately have more value than those that trade at $100—it’s all a matter of your net return.
Penny stocks typically trade at a lower price threshold for one of two reasons: 1) The company has become “distressed” and share price has fallen or 2) The company is relatively new and has yet to show earnings or achieve major notoriety in the investment community.
Brand Name or No Name?
Many investors confuse Penny Stocks with no-name companies that exist in a dubious corner of the market.
In point of fact, many Penny Stocks by our definition are household names with high market capitalization.
Been to the mall lately? No doubt, you’ve stumble upon Coldwater Creek:
Coldwater Creek (NASDAQ: CWTR) – Price: $0.87 – Market Cap.: $105 Million
And who hasn’t had a Moons Over My Hammy in the past few years at Denny’s:
Denny’s (NASDAQ: DENN) – Price: $4.20 – Market Cap.: $409 Million
The list goes on, and new entrants to the Penny Stock game happen every day.
Of course, there are other lower-priced stocks that exist in the penny market that are a bit more off the radar, but with major upside. And being informed of these lesser known stocks can give you a major advantage over everyone else who is simply following the traditional investment herd.
Take Lithium Exploration Group (LEXG), which has ranged heavily this year from as low as $.07 to as high as $10.68. This stock is listed on the OTC marketplace and is an “exploratory-stage” firm—essentially a startup junior miner with potential.
Let’s imagine a best-case scenario here: You bought 100 shares of LEXG at its lowest spot price of $.07, for a total cost to you of $7.00. If you sold that stock at its 52-week high of $10.68, you would have gained more than 15,000% on your investment, and netted $1061 in profits.
For less than the cost of your lunch, in less than one year, you now have enough for a family vacation.
Lithium Exploration Group (LEXG)
Purchase Price: $.07/share ($7.00 net)
Sale Price: $10.68/share ($1068.00 net)
Net Profit: $1061.00
Percentage Gain: +15,197%
Upside & Downside and Making the Right Pick
As with any type of stock purchase there are risks and rewards that you take when getting involved.
First, let’s look at the upside of Penny Stocks:
Low purchase price
High earnings potential
Quick earnings potential
Now, let’s look at the downside:
Lack of public information
Lack of liquidity in OTC markets
In the past, Penny Stocks have also been subject to “pump and dump” schemes by folks who take a large stake in a small firm, pump it up through media reports and speculation, and then sell off at a large profit.
So how can you be sure you’re avoiding the risks we have outlined here while only getting the rewards?
The most sure-fire way is to do your research and seek the counsel of a trusted adviser who deals with this market every day.
Making a quality investment takes time, whether you’re placing money in stocks on a traditional exchange or elsewhere. Penny stocks provide a unique opportunity, and through this Newsletter, you can gain the insight necessary to trade effectively, efficiently and maximize your returns.
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