Three Reasons You Should Not
Buy Penny Stocks, At Least Not Yet

Don't Buy Penny Stocks
If You Are Not Aware of The Risks Involved
You must have heard many stories on how people make money from these stocks. I buy penny stocks if I'd EXTRA money to 'play with'.

Because, you can gain as much as 300 per cent return in ONE WEEK with penny stocks, but in the same time, you can be selling your own shirts.

The reason is Penny stocks are not that cheap

In stock market, a stock traded for $45 does not necessarily is more expensive than another stock traded for $1. Why? Because, when it comes to stock investment, the business valuation determines how much the stock worth, not its price tags alone. I personally called this, calculate intrinsic value.

The simplest and easiest valuation method would be looking at individual Price to earnings ratio (P/E). The higher the P/E ratio, the more ‘expensive’ a stock is. Though P/E ratio is not that accurate, I find it very handy when it comes to stock’s valuation. You can simply spot which stocks are overvalued and which are not. From there, I’ll study if the undervalued stock is really ‘cheap’, or its price went down due to some other fundamental reasons.

However, the P/E ratios for penny stocks are normally much higher than the other stocks, blue chip stocks for example. This happens as penny stocks have much less historical earnings but many investors are betting on the expectation of ‘greater’ future profits. As you are aware by now, the higher the P/E ratio, the possibility for the price to increase further in months (or even years) to come is less.

Penny stocks are manipulative in nature

As the penny stocks are very cheap in price, stock investors and traders can easily manipulate their stocks by putting in large buy or sell orders. This especially true if 50 per cent or more shares of that particular stocks’ are floated in the stock market. After all, penny stocks have very low market capitalization.

Speculative investors and hedge fund managers are normally the major players for this kind of stocks. They form a syndicate team and agreed themselves to buy bulk of the share to pump up the share price. Then, they make a statement claiming this stock is the ‘hot penny stocks’ or ‘the next Microsoft’ through Bloomberg, CNBC or any business media.

As novice investors buy in the idea, more and more investors buy penny stocks, and the share price will eventually rise. When the time comes, these speculators will slowly but surely exit the market with the profits in hand.

If investors are no longer interested in buying more of that stocks, and if the speculators need the cash for other ‘syndicated stocks’, they’ll sell all their holdings and results to sudden price drops without any indicators. Experience before? Don’t worry; this does not happen in US market alone, but all over the world!

90 per cent business failed and so does penny stock

You might ask, if the P/E ratio is low, and the stock price doesn’t have much hype and speculation, can I buy penny stocks now? My answer will be, it still drill down to business performance. If the company has huge potential, why not? But even if it was cheap, what is the point of buying stocks with no business, right?

Statistic shows that, 90 per cent of worldwide wealth came from business, but it also indicate that, 90 per cent of business worldwide, failed within one to three years of operations. This is why, investing in a new company is very, very, very risky.

But hey, before these stocks get listed in stock exchange, they should have proven track record right? If that the case, these stocks is not a start up a company really.

And yes, you are right.

But ask yourself back, why they raised money in the stock market? They want more money to venture new horizon right? Sights that they haven’t reach yet. Is that much different with the small start up companies that also want to venture into new business horizon? I don’t think so.

Conclusion

Having said all these reasons, doesn’t mean that you can’t make any money if you buy penny stocks. Of course you can.
After all, many successful blue chip companies do start up as ‘penny stocks’ somewhere in the past.

It is just that, you must aware of the risks available and take the necessary actions to mitigate them. Stop loss order can be helpful. Though most prefer to buy penny stocks online, you could do better if you have a reliable penny stock broker.

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