Penny Stocks For Dummies. Peter Leeds
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with easier listing requirements and fewer serious investors. When they need to raise money, they often have to sell their concept first. They need to convince individuals, banks, and other creditors that they represent a good investment. Part of the job of a tiny company – and a potential distraction to operations – invariably becomes generating investor interest and expanding its base of shareholders. Insiders and key executives often front a major portion of any money a penny stock company needs; they know the potential the business holds, but the company doesn’t have enough of a following or history of operations to generate the money from a bank or outside investors.
Any penny stock has the responsibility to increase the visibility of its shares and its company. As it becomes more successful at this task, whether by listing on a more widely followed stock market or expanding the number of shareholders who are invested in it, the company may find that the price of its shares increases, perhaps even to the point where it no longer qualifies as a penny stock.
Larger stones take more force to move
The bigger something is, the more effort it will require to move or lift. This is not only true in the physical world, but in the stock market as well.
Multibillion-dollar corporations might encounter issues that they barely even notice, while those same events could derail or dramatically impact any micro cap company. While small events don’t tend to affect the prospects or direction of a blue-chip stock, everything matters when a company is new, tiny, or more vulnerable.
Larger corporations are also more diversified. They may have several business lines, thousands of customers, offices in dozens of countries, and a legal team capable of intimidating even the fiercest plaintiff. Penny stocks, on the other hand, often have a select few clients and revenue streams, so while any advances can really increase the share price, they’re also significantly more vulnerable to any losses or lack of improvement.
In the following sections, I describe some types of events that can dramatically affect penny stocks but that may not be significant to large cap companies.
The bigger a company becomes, such events will have proportionately less of an impact on the shares. Until that point, however, many issues will be of greater importance to penny stocks than mid cap and large cap companies. Although this vulnerability can represent massive downside potential if things go against the smaller business, it also clears the way for dramatic and lasting upside price gains when events play out as hoped.
Lawsuits
Besides being very costly and a distraction for the executives and shareholders alike, the outcome of a lawsuit can have a major impact on a small company.
Suits brought against a penny stock are usually a massive financial drain and, if the company loses, can mean lights out. When the penny stock is the one launching the suit, the action may demonstrate the company’s commitment to defending its products or patents through the courts; and if it comes out in the end with a good settlement or a victory, the results may be very beneficial. This assumes that it has the funds to see the litigation to the end.
Larger corporations devote a smaller percentage of their income to pay legal bills and have the financial luxury and insulation to launch or defend numerous court battles as they see fit.
Regulatory approvals or denials
FDA approval, a trademark grant, or a regulatory body award will have a much more significant impact on the share price of smaller companies. With some single-product corporations, a clearance or allowance is everything – without it, they go out of business; with it, they could change the world. On the other hand, a large cap corporation with 55 patents may not see a major impact when it wins its 56th patent.
Employee poaching or brain drain
Losing key employees is a very common problem for penny stock companies, especially among specialized technology companies. Bigger nanotech corporations, for example, often lure employees away from smaller nanotech businesses. The large cap companies can pay more and head-hunt more aggressively, while struggling and new penny stocks have a tough time thwarting these efforts. In some cases, a larger company will buy an entire smaller company for the sole purpose of gaining the employees.
Intellectual property events
The development and subsequent legal defense of trademarks, patents, and other intellectual property is very costly and time consuming, but such protections can help tiny companies level the playing field. Being granted the right patent can suddenly make a $500 billion corporation stop certain activities, pay royalties, or negotiate various aspects of its business. As such, intellectual property awards can have proportionately more impact on the shares of a smaller company.
Financial results
Penny stocks are often so new and small that the financial results demonstrate a lot more than just the numbers. Implied within the data is the validity of the product, the demand among customers, the growth trend, and client retention levels. When a micro cap company says that its sales increased by 20 percent, it’s also saying that its product or service has value and that more customers are buying or coming back for more. Financial results early in a company’s life cycle can reveal a lot more in terms of upside potential for the share price – and early viability of the business concept – than those released after years of operations.
Customer changes
When a company has fewer customers, winning or losing one will have more impact. Customer changes could be really great (such as a penny stock going from two to three big clients), or very detrimental to the company and its stock price (such as losing one of only two big clients).
Changes in competitors
When a penny stock loses a competitor, it may be able to pick up the market share that has become available as a result, and that benefit may be very significant for a small company. When that same penny stock sees new (and sometimes massive) competition enter its space, its best option is often to get bought out or taken over (see Chapter 3 for details), unless the company has the patents and trademarks it needs to defend itself and its sales channels.
Chapter 2
Deciding If Penny Stocks Are Right for You
IN THIS CHAPTER
Finding out why penny stocks are so popular
Understanding the big business of tiny companies
Getting a grip on the bad press surrounding low-priced shares
Determining whether penny stocks are right for you
You’ve probably heard both sides of the argument about the value of trading penny stocks. Many investors are afraid of penny stocks because of their risk, the low quality of the companies, and the potential for fraud and price manipulation. Others point out that penny stock trading is one of the few channels in which a small amount of money has the potential to turn into significant wealth so quickly.
The truth happens to fall between these extremes. Sure, any information that’s available about the stocks is less reliable, and the underlying company may be newer and more risky than bigger, more established stocks. But compared to bigger and more established stocks, that company may provide much greater returns as it grows.
You may have heard numerous horror stories about penny stocks, and get just as many warnings about them from professionals, friends, and family members. Yet, at the end of the day, you may decide to invest in these speculative shares anyway. That investment could be a big mistake, but if you get involved in fundamentally solid penny stocks by using the methods I detail throughout this book, you could also be making a very profitable move.
In this chapter, I explore the growing popularity of penny stocks. I also reveal the big business of tiny stocks and detail the numerous negative connotations surrounding low-priced shares. My aim in providing you with all this information is to help you decide if penny stocks are an appropriate investment vehicle for you.