NEW YORK (MainStreet) — Why purchase one share of Google when you can purchase thousands of shares of a smaller company?
Why purchase an already mature Exxon when you can purchase what may be the next Exxon?
It is misleading questions like these that lead investors to venture into the risky world of penny stocks.
There appear to be two main reasons investors are attracted to penny stocks; they want to own a larger number of shares, and they believe they are about to find the next big thing. This is a fallacious argument, however, and penny stocks are likely to lead to financial ruin rather than riches.
Owning a larger number of shares has no benefit. While it may appear that your potential for profit is greater, that is not the case. Yet this continues to be a lure for penny stocks. A huge number of investors would rather own 1,000 shares of a $1 dollar stock rather than one share in a $1,000 dollar stock. The idea of owning a greater amount of shares makes a small investor feel like their profit potential is higher, when in fact it is the same.
Penny stocks are also highly susceptible to manipulation. Since they receive no media coverage, any mention of a penny stock can send it soaring. Have you ever received a spam email where a self-proclaimed "expert" touts Apple as the next big thing? Probably not. It is always an unknown company that trades for pennies. Then, after the investing public sends the price of this stock up, it crashes after the "expert" sells the stock. This is classic pump and dump.
Furthermore, many investors are enticed by penny stocks, because they believe they will find the next big thing. When looking at a chart of Wal-Mart, it would appear that the stock traded under $0.10 in the 1970's, thus lending credence to the argument that a penny stock may be the next big thing. Yet, many people overlook the fact that the prices shown for Wal-Mart have been adjusted for the many stock splits they have had throughout the years. It went public for $16.50, and it has never been close to being a penny stock.
When evaluating any stock as a potential investment, it is important to read SEC filings, study analyst reports and listen to company conference calls. One must look at the track record of these companies and see how it has performed over time. This luxury is not available with penny stocks. Many of these companies are unknown with little to no assets, zero analyst coverage, zero media coverage and no track record.
The idea of striking it rich on a penny stock can be enticing, but the odds of this happening are slim to none. The likely result will not only be an investment that loses value, but an investment that loses all of its value.
--Written by Alex Pottmeyer for MainStreet