When it comes to stocks, there are few investments that are riskier than low-priced stocks. These stocks with a price of less than $5 per share are usually priced so low for good reason. For example, a penny stock may belong to a once thriving company that is now on the verge of bankruptcy or has to be delisted from a large exchange and is now trading over the counter (OTC). It may also be a new company, so it has little market history and has not yet reached the standard for listing on a major exchange.
Penny stocks are inherently volatile and risky, and they are particularly vulnerable to price manipulation. However, occasionally, a penny of stock will greatly reward investors who are hungry for risk. If you bought Monster Beverage Corporation (MNST) stock at a price of $0.04 per share in 1996, you will be a happy investor today: Monster will trade at more than $66 in 2020.
If you are interested in finding the potential for this type of exponential return, it may be worth exploring the dark side of low-priced stocks.
- Penny stocks are low-value stocks that are usually traded over-the-counter because they do not meet the exchange’s minimum listing requirements.
- Penny stocks are far more risky than listed stocks and are susceptible to manipulation.
- However, some low-priced stocks may be diamonds in the rough, offering unparalleled profit potential.
Check the basic principles
Investors should conduct thorough due diligence before taking risks on any low-priced stocks. For example, investing in troubled Walter Energy seems to be a good choice.After all, Walter Energy’s transaction price is as high as USD 143.76 per share in 2011But those who bought when Walter Energy fell to $0.16 will still be burned because the company will soon declare bankruptcy.On the other hand, the investment of Inovio Inc. (INO), which traded at less than US$1 in 2008, provided investors with many opportunities to exceed US$10 in 2009 and from 2013 to 2020.
The stark contrast between these two stocks lies in the company’s fundamentals. Walter is a mature metallurgical coal company, which is an aging industry, subject to cyclical demand and political pressure. When world leaders made promises to reduce greenhouse gas emissions, this put greater downward pressure on Walter Energy, which has already been frustrated by a global oversupply of coal and a slowdown in Chinese demand. Walter finally sold its assets to two companies in 2016.
In contrast, Inovio is a speculative biotechnology company that has established a strong partnership in its cancer vaccine product portfolio and has strong acquisition potential. By 2020, the acquisition has not yet occurred, but the stock continues to sell, and then sees the huge upward trend quickly dissipating.
Therefore, when studying low-priced stocks, you should carefully weigh any potential earnings with the company’s fundamental factors: debt, cash flow, acquisition potential, and Porter’s five competitive forces. Before you even consider buying, you should have a complete understanding of why the stock is trading at the current price.
Just like any stock purchase, when considering buying penny stocks, fundamental analysis and due diligence on the quality of company management can help lead to winners and avoid losers.
Industry life cycle analysis
In addition to analyzing the company’s balance sheet, penny stock traders should also conduct industry life cycle analysis. Some low-priced stock companies are still in the “exploitation period” in the industry. This initial stage is characterized by a large number of small competitors in this field, novel products and concepts, and low customer demand for products. Due to the emergence of a large number of startups (especially technology or biotechnology companies) during this period, all of these companies have high costs and have almost no sales so far, so most of these companies will trade them at very low prices Speculative nature.
After this initial phase is the “growth phase”, many of these companies have gained greater market attention, so their sales and demand have skyrocketed.
A perfect example is the technological boom (and collapse) of the late 1990s. Many technology startups started with a penny of stock, and then experienced astronomical growth in market value and valuation as investors grabbed anything related to the novel Internet concept at the time.
Penny Stock Industry
Industries that provide binary results for most of their companies will not surprisingly contain a large number of low-priced stocks. Binary outcomes, or “success or failure” speculative games, mainly appear in the fields of biotechnology or resources.
The Canadian TSX Venture Exchange is home to many resource-based low-priced stocks that emerged during the commodity boom in the 2000s. Then the party ended, and most stocks plummeted to zero, similar to many technology stocks in the 2000 crash.
However, when conditions are favorable, such as when commodities are booming, traders can still use binary companies. But investors in these fields must also realize that stocks are falling as fast as they are rising.
In real estate, everything is related to “location, location, location”. For penny stocks, it is “management, management, management”. Sound management can reverse a troubled company and push startups to new heights. More importantly, the experienced and ethical management of the company’s vested interests through equity holding can provide investors with a sense of security.
Of course, superstar managers working in low-priced companies are not common, but there are a few examples. Take Concur Technologies as an example. The company rebounded from the post-tech bubble price of US$0.31 and was acquired in 2014 at a price of US$129 per share.This extraordinary return is attributed to multiple factors, but what stands out is the strong vested interest of the president and chief operating officer Rajev SinghSingh co-founded the company in 1993. After Concur was acquired by the software giant SAP SE (SAP), he ended up holding too many management positions throughout the company’s life cycle.
Penny stocks are extremely volatile and speculative in nature. Since most of them are traded over-the-counter or through pink sheets, the listing standards are loose, and penny stocks are susceptible to manipulation and fraud. Nonetheless, the potential for huge returns is still very attractive, prompting risky investors to build positions in these securities. Although many low-priced stocks have gone bankrupt, if investors conduct careful fundamental analysis and choose a sound management team, they may find coveted diamonds in the rough.