Topic: Penny Stocks

Great Penny Stocks Rarely Exist, even If you are willing to risk money on “Ground Floor”’ opportunities

You can search high and low for great penny stocks—but in penny stocks or games of chance, the odds are not in your favour. Time works against you. The longer or more often you play, the likelier you are to lose.

When looking for new investments to recommend, we look for a number of key factors. These include a prominent place in an industry, a history of earnings if not cash flow, a history of dividends, involvement in a fast-growing industry, hidden assets, the possibility of a takeover bid, and many others.

What’s more, when picking stocks, we try to figure out if the company’s business is likely to do well in the immediate business environment, how it might react to a business setback, and how likely it is to prosper in the years and decades ahead.

However, even “great penny stocks” seldom possess these attributes.

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Even “great penny stocks” fail for a number of reasons

Penny stocks have appeal for some aggressive investors who aim to get into fast-growing stocks at what they describe as “the ground floor.” They think the best way to profit in stocks is to buy them when they are just barely starting out on a growth phase that can last for years if not decades. Ideally, they want to buy the future top performers when they are still near or close to the penny stock range and have yet to be discovered by the broad mass of investors.

These investors rarely find what they’re looking for. That’s because there’s a large random element in investing, especially at the ground floor. Many promising junior stocks fail to thrive as businesses for any number of reasons. To borrow from the opening lines of Tolstoy’s Anna Karenina, successful stocks tend to have a lot in common, whereas unsuccessful stocks tend to suffer from their own unique sets of risks and faults.

Sometimes stocks with intriguing business concepts just never get anywhere. They generate a number of encouraging news releases, but these releases turn out to be a series of exaggerations and broken promises.

Promising stocks may start out with a brilliant idea or a plan to get involved in a high-profile or fast-growing business area. They may enjoy an initial burst of sales or even earnings. But many just can’t keep up the momentum. They never reach the critical mass they need to achieve consistent profitability.

It’s also worth noting that the vast majority of large, successful companies did not start out as great penny stocks. Companies like Walmart, Microsoft, or even Facebook never traded at the penny stock level—they started out at much higher levels and went up from there. This is more common than examples of great penny stocks that grew into major companies.

Factors that great penny stocks should have to be attractive—but almost never do

  • Well-financed companies
  • Strong management
  • A strong balance sheet
  • Reasonable share prices
  • A results-focused company
  • Stocks trading on a well-regulated exchange

Penny stocks are not typically among our recommended stocks

Investors looking to add to the aggressive portion of their portfolios may turn to the higher-risk strategy of buying penny stocks.

However, there are several potential risks when investors venture into penny stocks.

Buying low-quality penny stocks is one of those things that can appear to be successful before it goes badly wrong. Some get hooked on it, since low-quality stocks can be highly profitable over short periods. That’s because they are generally more volatile than high-quality stocks.

If you lose money in speculative pennies or other low-quality stocks, you may think your biggest mistake was bad timing. That’s a misconception. All penny stocks rely on luck to become wildly profitable. If you play long enough, the “house odds” eventually triumph over any run of luck.

In penny stocks or games of chance, the odds are against you. So, time works against you. The longer or more often you play, the likelier you are to lose.

On another note, some investment beginners think they can trade penny stocks when they are just starting out, then switch to more conservative investing later on, after they’ve built up their small investment portfolio into a large one. But if you could succeed in that initial small-portfolio-to-large-portfolio leap, why would you change anything?

For that matter, if turning a small portfolio into a large one was that easy, why would anybody work?

Our long-standing advice is to invest in a portfolio of well-established companies spread out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities. Stay out of penny stocks of any other high-risk investments. This way, while you may experience modest losses when markets drop, you should show overall positive results over time.

Do you own any great penny stocks? What fundamentals led you to initially invest in them?

What factors would a penny stock have to have for you to consider investing in it?


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