Novice Investing - The Allure of Penny Stock

Date: Monday 01st 2008f December 2008 05:24:55 PM

The Allure of Penny Stock - 05/28/2006

By: Novice Investing Staff

Ahh....the world of exciting penny stocks, where the big gains are made. So, what are penny stocks? Penny stocks are shares that trade below $ 5 per share. Some trades for as low as $ 1. One of the most compelling reason in investing in penny stocks are its outsized gains. Stock that goes from $ 1 to $ 6 will give you a return of 500%. For 'normal' stock with a share price of $ 50, it needs to go up to $ 300 to give the same percentage return; a more difficult feat to achieve.

So, what stops most of us from touching these penny stocks? The magic word here is bankruptcy. These penny stocks are traded below $ 5 for a reason. For most, the reason is their survival as a going concern. If you sift through thousands of penny stocks, you will mostly find companies with high debt and low cash level. Meanwhile, they would spot a big loss on their income statement, mainly due to poor economics or poor management or both. This combination normally ensure that the company arrives at the bankruptcy court soon.

So, what should we do with Penny stocks? You should treat it the same with other common stock. Having a strong balance sheet and profitability is a recipe for success, regardless what price the stock is trading for. However, penny stock is generally more volatile and as a result, if the share price drops, it will drops more heavily. On the other hand, when it becomes undervalued, it will be quite a bargain. Thus, penny stock is a high risk high reward situation.

95% of penny stocks will eventually go to zero. Thus, it makes it an uneven playing field if you invest in penny stocks. The proponent of this investing style reason that one winner will more than offset the loss occurred on a few of the penny stocks picks. The rest is up to you. If you can stomach penny stocks volatility and stick to penny stocks with solid balance sheet, your odd to success will be much more.

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding any securities.

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