Are Penny Stocks Worth It?

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Topic: Penny Stocks

Penny stock promoters sometimes just don’t know any better

penny stock promoters

Penny stock promoters feel like they are doing the right thing, even when they are not. This is a form of “orthodoxy” that can develop within a penny-stock promotion.

In the 1980s, the Vancouver Stock Exchange was a world centre for trading speculative stocks. And at that time, I used to advise buying some Vancouver stocks that seemed like they had a chance of success, and recommend selling or avoiding others.

That’s when I noted a recurring pattern: when I advised selling a stock, the company hardly ever responded in any way. Assuming they knew about the sell recommendation, it seemed they just wanted to avoid any unfavourable attention. The rare exceptions were companies that were particularly successful in promoting their stock, but seemed to have the least likelihood of success as a business.

Rather than ignoring our sell advice, penny stock promoters of some doomed business ventures would send incredibly long, detailed, indignant letters. They would insist that I explain how I came to such a ridiculous conclusion, and demand a retraction. Sometimes I would print an update or clarification about the company’s business. But I never did find reason to change any of these recommendations. So I’d add at the end of the piece, “We still think it’s a sell.”

At the time, I wrote these penny stock promoters off as liars and cheats. Looking back now, I’d say that’s the simple way to look at it. There is another explanation: this is an example of a form of “orthodoxy” that can develop within a business or a penny-stock promotion.

Are Penny Stocks Worth It?

Learn everything you need to know in 'Canada's Penny Stock Guide' for FREE from The Successful Investor.

Canadian Penny Stock Guide: Find where to find Penny Stocks that pay well.

 I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

People often think of orthodoxy as an attribute of religious groups. But it’s an all-too-human phenomenon that turns up in many parts of our lives, including science, nutrition, finance, investment and elsewhere. People incorporate their strongest beliefs into their social lives, livelihoods and positions in society. Questioning their orthodox dogmas makes them fear that any change will undermine their income, jobs or reputations.

One key indicator of an orthodoxy is the indignation that it inspires when anyone questions it. In the 1980s, for instance, a Bay Street investment analyst published a research report that predicted a 25% drop in the price of the average Toronto house. The analyst came to this conclusion by studying a number of measures related to Toronto houses, using the same techniques he used to tackle economic and investment issues.

He concluded that average Toronto house buyers could no longer afford to buy average Toronto houses. Prices had simply gone too high. He didn’t advise anybody to sell. But his argument might have made some people hesitate to buy.

The city’s real estate brokers were outraged. They didn’t want to argue with his methods or conclusions, which were based on statistics and common sense. They attacked the man instead of his prediction. They launched a public relations campaign to counter the idea before it caught on.

They claimed, “He doesn’t know what he’s talking about!” They tried to get the media to focus on questions such as, “Doesn’t he know that Toronto has turned into a world-class city?” and “Why doesn’t he stick to his own specialty?”

Their campaign had no impact on the market. Within a couple of years, however, Toronto house prices had indeed dropped 25%.

The funny thing is that uncovering the holes in one orthodoxy is no guarantee that you won’t become part of another. After his success with the Toronto house price market, this particular analyst got interested in oil prices. His analysis told him that oil was bound to go way, way up. He predicted this would lead to changes in the lives of virtually everybody on the planet.

This was a few years ago, when the “peak oil hypothesis” was at its peak in popularity. “Peak oil” is the idea that world oil production will eventually reach a maximum rate, then go into a terminal decline. Studying past oil production is supposed to make it possible to predict the date when we’ll hit that maximum rate.

This idea started to come up as early as 1919, when a U.S. government geologist wrote that the U.S. could reach its maximum oil production within as little as three years. In the early 1950s, geologists at multinational oil companies began to think U.S. oil output could peak by 1960, and world output by 1985.

Of course, multinational oil companies have always had good business reasons to predict that the world was running out of oil. It helped support their argument for more favourable tax treatment from governments, to leave more money for exploration.

Peak oil theory gained stature in the final decades of the 20th century, particularly when oil prices were on the rise. However, each revision of the theory pushed the coming peak in oil prices a few years further into the future.

Oil reached an all-time high of $140 U.S. a barrel in late 2008, just prior to the recession. Peak oil orthodoxy seemed to reach its peak influence around the same time.

Then, in the recession, the price of oil plunged to a little over $40. It shot up to $115 in a little more than a year, then spent the next few years between $80 and $100. It then set off on the plunge that took it down to today’s prices.

Today, you don’t hear much about peak oil theory. People seem to have accepted the obvious idea that past oil production has little to do with future supply. That’s because production methods and targets have changed. We no longer need to look for those rare pools of “liquid” oil that sparked the boom in oil use more than a century ago. Now, thanks to modern technology, we can extract oil from shale and other types of rock that are plentiful in many parts of the world.

No one knows if the price of oil will average $20 or $80 a barrel in the next 10 years. That depends on a lot of volatile factors, including political and environmental opposition. We do know that, thanks to technology, a lot more oil is available for production than in the past. Better yet, these new oil sources are spread around the globe, and not concentrated in militarily and politically volatile areas like the Mideast and Venezuela.

This is sure to lead to far more stability in oil supplies. Prices will remain volatile, but we’ll be able to take oil availability for granted, just as we do with most commodities. I see this as a big long-term plus for the world economy and stock market.

In summary, some penny stock promoters are just doing their jobs, maybe even reporting the facts as they see them, and some are out to make money at any cost. The goal is to develop the innate ability to see a penny stock promotion for what it is and when to know a company has actual growth potential.

Are you considering buying penny stocks? Have you bought some in the past? Have they been winners or losers? Share your experience with us in the comments.

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