Penny stocks allow investors to diversify their portfolio by targeting areas of the market that are more prone to volatility, which can lead to outsized returns for the portfolio. Penny stocks are self-descriptive, each share sells for as little as a penny to as much as $5. However, these mere pennies can be far away from the intrinsic value of the stock, either higher or lower, and thereby cause a high degree of risk, or reward.
Nature of Penny Stocks
Penny stocks allow access to smaller markets that aren’t adequately covered by large or even mid-cap stocks. Often times, they don’t have earnings, and sometimes not even revenues, and, as such, no price to earnings (P/E) ratio can be applied. This makes the value of a penny stock difficult to monitor or assess. Add to that, few analysts follow penny stocks, as it is not cost-effective for brokerage houses to pay analysts to do so, so these instruments often fly under the radar. Penny stocks are frequent in industries such as pharmaceutical bio-tech start-ups, other developmental stage companies, as well as businesses in other speculative industries.
Penny Stock Risks
As these instruments are not frequently followed by analysts; it may be difficult to obtain enough information about management to assess their honesty and integrity. In addition, revenue streams may not be stable, and, as a result, it may be difficult to monitor the net book value of the business. It is also difficult to determine whether the company has sufficient assets or financing (either equity or debt) to remain in business until stable revenue sources arise.
The risk of owning stocks is the amount of your initial investment. That is the beauty of owning stocks, particularly penny stocks. As such, it may be useful to make a small investment in a penny stock. These are risky instruments, and the volatility of the price of these stocks illustrates this. Day trading penny stocks is particularly risky, however, selecting a company with volatility as high as penny stocks, one has to really monitor the entry price.
Starting to Invest in Penny Stocks
If you want to learn penny stocks and start investing, you should begin by obtaining a broker that allows access to OTB markets (off the board) which give you access to penny stocks. Search for industries that interest you and try to find companies with strong management, whom have access to financing, and who have an idea that can fill a need that customers have. Penny stocks have risks associated with them, but can also yield fabulous returns.