Penny Stocks

What are Penny Stocks?

The typical penny stock is a relatively very small company with speculative and highly illiquid shares. The company will also generally be subject to limited listing requirements along with fewer filing and regulatory standards. All though, it may lead to confusion because there is no exact definition to "What is a PennyStock?". Here are a few examples of what may be considered a Penny Stock, many believe it is any stock that trades for pennies or for less than 5$, while others consider any stock trading off of the major market exchanges as a pennystock. The term itself is a misnomer because there is no generally accepted definition of a penny stock. However, confusion can occur as there are some very large companies, based on market capitalization, that trade below $5 per share, while there are many very small companies that trade for $5 or more.

According to the Securities & Exchange Commission (SEC) any stock under $5 is a penny stock. Again, definitions can vary, some set the cut-off point at $3, while others consider only those stocks trading at less than $1 to be a penny stock. Finally, we consider any stock that is trading on the Pink Sheets or OTCBB to be a penny stock.

The most important and useful think to know about penny/micro stocks is that they are much riskier than regular stocks.

Why are Penny Stocks Riskier?
Four major issues arise when you decide to invest in Pennystocks :

Lack of History :
Most of the companies considered to be penny stocks will generally have a poor track record or none at all because they are either newly formed companies or approaching bankruptcy. As we know, the serious lack of history only magnifies the complicated process of picking the right pennystock.

Lack of Information Available to the Public :
The key to any successful investment strategy is gathering enough tangible information which can help you make an informed decision as to what stock to purchase. For pennystocks, useful information is getting harder and harder to find. Most of the information available to the public is not from a credible source, companies listed on the on the pink sheets are not required to file with the SEC and are thus not as publicly regulated as the stocks represented on the NYSE and the Nasdaq exchanges. Therefore, there is a huge lack of information available to the public about Penny Stocks.

Liquidity :
Two problems arise when stocks don't have much liquidity. First, there is always a possibility that the stock you purchased cannot be sold. If there is a low level of liquidity, it may be difficult to find a buyer for a specific stock, and you may be required to lower your price until it is considered attractive by other potential buyers. Second, low liquidity stocks give traders the opportunity to manipulate stock prices, which can be done in many ways. The easiest way would be to purchase a large amount of stock, hype it up, and sell it once other investors are finding it attractive, also referred to as the pump and dump.

No Minimum Standards :
Stocks trading on the OTCBB and Pink Sheets do not have to fulfill minimum standard requirements to remain on the exchange. Sometimes, this can explain why a stock is on one of these exchanges, once a company can no longer maintain its position on one of the major exchanges, the company moves one of these smaller exchanges.

 

Misleading Public Information :

The significant lack of reliable, available information about microcap companies opens the door to fraud. It's much easier for fraudsters to manipulate and control a stock when there's little or no information available about the company.

Microcap fraud depends on spreading misleading and even false information. Here's how some fraudsters carry out their scams:

"Boiler Rooms" and Cold-Calling :
Dishonest brokers set up offices where high-pressure salespeople make hundreds of cold calls a day to as many potential investors as possible. These strangers trick investors into purchasing "house-stocks", stocks that the firm buys or sells as a market maker or simply has in its inventory. A successful Boiler Room definitely has a negative effect on the OTCBB and Pink Sheets.

Questionable Press Releases :
Fraudsters put a lot of time and effort into writing questionable press releases. Decorated with exaggerations or lies about the microcap company's sales, acquisitions, revenue projections, or new services or products. These fraudulent press releases are then disseminated through legitimate financial news portals on the Internet.

Pump and Dump Internet Spam :
This is a popular scam where millions of unwanted spam emails hype shares of a little known company, of which the spammer's team has previously acquired stock. When sufficient people fall for it and rush to place buy orders, the market value of the stock rises and the spammer can sell at a profit.

Poop and Scoop :
The converse of a Pump and Dump is a penny stock fraud called the Poop and Scoop. Here, the scammers manipulate the market by spreading highly negative false information to drive a stock down. Once the stock plummeted, they purchase large amounts hoping the price will bounce back to it's normal value.

 

How to get Information on Microcap Companies :

For those working with investment advisors or brokers, you can ask your investment professional if the company files reports with the SEC and to get you written information about the company and its business, management and finances. Carefully analyze any information handed to you, the prospectus and the company's latest financial reports.

Here are some legitimate sources you can use to collect more information on your own :

From commercial databases and reference books :
Many reference materials containing valuable information on companies is available at your local public library or the nearest law or business school library. For more information about the company's history, products or services, management, credit ratings, and revenues , is available in commercial databases.

From the SEC :
A large number of companies must file their reports with the SEC. Using the EDGAR database, you can find out whether a company files with us and get any reports in which you're interested.

From the Company :
Contact the company to find out if it files reports with the SEC. If it is a smaller or unknown company chances are it doesn't file with the SEC. You should also call your state securities regulator to get information about the company, its management, and the brokers or promoters who've encouraged you to invest in the company.

The Secretary of State where the Company is Incorporated :
You may contact the secretary of state to at least find out whether the company is a corporation in good standing. You can also obtain copies of the company's incorporation papers and any annual reports it files with the state.

For More Information Regarding Penny Stocks :

1. Are Penny Stocks Worth a Look?

2. Inflated Penny Stock Prices

3. In for a Penny Stock

4. Penny Stocks Offerings Plunge

5. Poof It's Gone

6. Prince of Penny Stocks

7. The Penny Stock Express

8. Wary Eye on Penny Stocks