What is a Penny Stock?
In layman's terms, this is a common stock that trades for less that $5 per share and typically is traded on the 'over the counter' (OTC) or outside of the major stock exchanges such as the NYSE or NASDAQ. A great number of penny stocks trade for well under $1 and quite a few actually trade for fractions of one cent!
Many new businesses get their start: as 'penny stock companies'. To raise capital to get their business off the ground, a new company will offer common shares of stock in their business. Because they are unknown and unproven, they are usually viewed by investors as being very risky. So, their initial offering can literally be valued at well under one penny per share. Hence the moniker: 'penny stock companies'.
In fact, I have owned stock in several companies for which I paid just $0.0001 per share!
This is very important if you are serious about investing and not just gambling in the stock market.
#1. Proven, experienced management in their field.
#2. A track record of success. There are very few penny stock companies with this under their belts, but if you can find one that is successful - that's a great find!
#3. Profitability. Have they ever made any money? See #2
#4. Product quality. Is what they are selling real? Viable? Sustainable?
#5. Competition. Are they innovators? Who is the competition?
#6. Funding resources? Very important! Do they simply sell more and more shares to raise capital OR do they have other funding resources?
#7. Have they executed reverse splits in the past? (Click on underlined link for definition.) Announced or discussed future reverse splits? This is a major warning signal. It's considered as a "tombstone" in the penny stock world and is very often a sign of impending ruin for the company and the investor! (I suggest you learn more about this!)
Things you cannot control when Buying Penny Stocks:
#1. The company you invested in. You are technically an owner and sometimes they will send out proxy vote ballots, but essentially, once you buy stock in a company, you are trusting their managers to make good choices.
#2. Market makers. These are stock trading entities that can heavily influence the price of a penny stock for their own gain - up or down, (very often, down). Many are legitimate, but others are not. I prefer to call them market "manipulators" and small company killers.
The SEC (Securities and Exchange Commission), for whatever reason, virtually lets market makers run uncontrolled - although some recent crackdowns have occurred. I still think much of their activity is criminal.
#3. Message boards. These are website forums for specific stocks. Going in, you might think: "hey this is a great chance to converse with fellow investors!" Guess again! There are many predators on these boards attempting to manipulate investor sentiment and ultimately stock price to their advantage. Truth is not an issue here. It's a free speech vehicle that I stongly suggest you stay away from. I contend that many participants on these boards are market makers preying on gullible investors.
#4. Competing companies.
#5. The economy.
I hope I didn't scare you away from buying penny stocks. That wasn't the intent. But, I have invested in many penny stock companies with great products and potential, only to see them ruined by forces out of their control (and mine).
Again, consider this to be a "buyer beware" discussion. Always do your homework before investing in any stock.
With all that said, I still like the odds of success from buying penny stocks better than buying lottery tickets! Good luck!