Penny stocks are stocks that have a low share value, typically less than $5. They may also have a market capitalization of less than $500 million. These shares are not traded on formal stock exchanges, but they are traded on Over The Counter Bulletin Board (OTCBB) and Pink Sheets.
In order for a penny stock to be listed on the OTCBB, it has to follow certain rules and regulations laid down by the Securities and Exchange Commission (SEC). However, to get listed on the Pink Sheets the company need not follow any rules and regulations laid down by the SEC. In fact, they do not even have to disclose their financial statements to the public.
So how does one choose the right penny stocks? Penny stocks are an attractive investment for some investors because of its low value. The investment required to buy these penny stocks is very little. However, a lot of risk is involved. This is the primary reason why mainstream investors and financial institutions keep away from these stocks.
When one picks the right penny stock, he or she can make a lot of money when the value of the stock goes up. However, these stocks are easily prone to manipulation. Many frauds happen in penny stocks.
The following is a typical kind of fraud that is committed in the OTCBB and Pink Sheets. A fraudster will buy a lot of penny stocks of a particular company on a given day. As their volume is thin, a buy transaction will increase their value. Innocent or novice investors will get carried away by this trend.
They in turn will buy more shares and the value will go up further. The fraudster, after making a considerable profit, will dump all the shares. This will cause the value to drop drastically. In the whole process, the poor investor may lose a lot of money, sometimes even the entire capital.
When a person has decided to invest in penny stocks, he or she must take utmost care to ensure that they are not cheated in any way. The only way to insulate oneself from the scams is by doing a thorough research.
An investor must look into every company’s current value, past performance, profitability, market value, growth fundamentals, ability of the management, trend of the industry, growth to earnings ratio, average percentage of stock appreciation over the last few years, forecast for the next few years, the line of products and the capacity of the company to earn sustained profits over a period of time. If the above factors are favorable, then one can go ahead and invest in these stocks.
By doing this research, the investors can be assured that they will make money in the future, irrespective of the vagaries of the current stock price.
It is better to keep away from companies that do not have too much information available for the public. These companies will mostly be traded on the Pink Sheets. Penny Stocks can give good returns in the long run, provided the investor does a thorough research on the soundness of the company.