Why These Stocks Will Cripple Your Portfolio
Alexander Green
Chief Investment Strategist
Due to the stock market's recent woes, investors have been able to buy many fine companies for less money.
Yet some want to go all the way down to the cellar. "Why don't you ever recommend penny stocks?" one subscriber recently asked. "After all, it's easier for a 50-cent stock to go to $1 than for a $50 stock to go to $100."
For starters, it's not.
Over the years, dozens of studies have shown that lower priced stocks don't do better than higher priced stocks. In fact, they do considerably worse.
While it's not easy for a 50-cent stock to go to $1, history shows that going from 50 cents to zero is like falling off a log.
There are other reasons why I won't touch penny stocks with a barge pole...
Why Penny Stocks Stink
~ Long Shots: The vast majority of tiny, unprofitable companies are such ridiculous long shots, they don't even merit your attention. Most of these companies have little, if anything, in the way of profits, not to mention the first prerequisite: sales.
~ Wide Bid/Ask Spread: You could drive a cement mixer through the bid/ask spread on many penny stocks. For instance, if a stock is offered at 30 cents and bid at 24 cents, you're down 20% as soon as you get your trade confirmation. (And that's before commissions.)
~ Low Liquidity... High Risk: Penny stocks are thinly traded and easily manipulated. You may buy a penny stock and see it zip higher. But then try getting out. It's pretty disheartening to know that you can drive down the price of your stock simply by selling a couple of thousand shares at market.
And then there are the outright scammers...
Don't Fall for the "Pump-And-Dump"
Often referred to as a "pump-and-dump," a penny stock scam is when the insiders talk the stock up on one hand while bailing out like there's no tomorrow on the other.
That's usually because despite the great story (and make no mistake, the stories are always fabulous) the company's genuine business prospects are usually nil. But penny stock promoters want you to trust them and believe in the hot tip.
If you're going to evaluate a penny stock, here's how the penny pushers would like you to do it:
By recognizing the multi-billion dollar market they intend to operate in.
By considering the enormous profits they'll generate when their technology is finally commercialized.
By noting the proven reserves of the mining company operating next door.
By the preliminary results of their Phase I trials.
By any criterion you can think of except what the company is actually earning... because that figure is virtually always zero.
If you insist on discovering these lessons for yourself, if you doubt my words, or for some reason are drawn to penny stocks like a moth to a flame, at least take a few basic precautions before you invest...
Penny Stock Precautions
Start by reading the company's most recent quarterly or annual report. Then look for the following...
Does the company have sales or earnings?
What kind of debt is it carrying?
How long has the company been in business?
Who are the people behind it?
What is their track record?
What is their rap sheet?
In other words, if you're going to roll the dice, make sure it's a genuine speculation, not just a mindless crapshoot.
Also, take a look at what the insiders are doing. If the insiders - the ones who seem unable to contain their enthusiasm for the company's near-term prospects - are dumping the stock en masse, you know all you need to know.
Run.
Some will say I'm unduly pessimistic. (Penny stock promoters, especially.) And clearly, a few successful companies did start out as penny stocks.
But for every success story, there are hundreds of penny stocks whose charts bear an uncanny resemblance to the last flight of the Hindenburg.
In short, there are plenty of smart ways to invest your money. Toying with penny stocks, in my view, is one of the dumbest.
Good investing,
Alexander Green
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