The question of stocks
vs penny stocks, (aka
low-capitalization stocks, or OTC
Stocks), is one that enters almost
every investors mind at one point or another. It’s
an interesting question to consider too, as there
are quite large differences between the stocks that
most people see listed on the major indices and the penny
stocks that are only traded over-the-counter (OTC).
And you likely won’t be surprised to learn that many
of these differences rotate around the concept of
risk.
Of course, before we begin any discussion of stocks
vs OTC stocks it’s important to have a definition of
each so we can understand exactly what it is that
we’re comparing. When we talk about
“stocks” we are usually referring
to publicly traded companies that have been listed
on major exchanges like the New York Stock
Exchange. These are often, but not
always, well-known names and larger, more stable
companies. Investors often prefer this type of stock
because it can be considered a “stable” investment
that will provide a long-term growth horizon.
The very best of the regular stocks give an investor
the combination of a relatively inexpensive price
based on the company earnings, a solid and rising
dividend, and good growth prospects. In general, the
best regular stocks share these common traits:
- They are stocks of successful companies
- They have a dividend that’s been increasing
regularly
- They have good cash flow, strong management, and
prospects for growth
These are the stocks that a long-term portfolio is
built around.
Penny stocks typically do not display any of these
characteristics. Instead they offer to traders a
potentially large gain in a short period of time.
Unfortunately, this chance to score a big gain also
comes with increased risks, and it is far more
likely that a trader will be disappointed by the
performance of the OTC stocks they invest in as most
remain relatively unchanged, and some even drop
significantly from their already low valuations.
Penny stocks are inherently riskier and often
engaged in risky behaviour in order to get a hook in
their industry. Investors need to be extra careful
about the low-capitalization stocks they choose to
speculate on, lest they end up losing a pile of
money rather than making a pile of money.
Speculation in Stocks vs Penny Stocks
Investing in regular
listed stocks is rarely considered
speculation. Instead it is called investing.
Speculation typically involves much greater risks,
and potentially much greater rewards, while
investing expects a steady and stable increase in
the value of an asset. Of course, there are merits
to both, depending on the goals of the trader. And
it’s possible to invest in regular stocks while also
speculating in smaller penny stocks. When it
comes to making money there are times when an
investment in a regular stock ends up turning into a
loss. Choosing a company’s stock at the wrong time
could lead to losses if the stock struggles due to
poor management, a challenging business environment,
or a number of other factors. However, in the long
run these stocks can and often do recover. And in
the meantime, many of them also provide the investor
with a steady cash-flow in the form of dividends.
With penny stocks it is far more likely that you will
lose money, and that the stock will never recover.
It is also more difficult to choose a good OTC stock
to invest in because often the only reason the
stocks end up soaring higher is strictly down to
luck. Recently Elon Musk’s tweet sent penny
stock soaring, but company insiders didn’t
sell shares. The problem is that for every penny
stock where a trader gets lucky there could be three
or five or even ten where he doesn’t get lucky.
These others can simply end up as a wash as the
stock doesn’t move much, or they can end up as a
massive loss.
That’s why investors often mix regular stable stocks
with a small allocation of OTC stocks that increase
the speculative and aggressive portion of their
portfolio. It’s important to understand that
the risk of loss with a penny stock is much greater
than the chance of success. If you plan on
speculating on low-capitalization stocks there
should be a very strong reason to buy the stock.
Some information that could lift the stock in the
future or some change at the company that could make
the shares more attractive. The worst course to
take with penny stocks is simply buying them on a
hunch or a whim. This is typically no better than
going to a casino and spinning a roulette wheel. You
might win once or even several times, but eventually
the house is going to win and empty your pockets.
Penny Stocks Prospects are often Exaggerated
A large company with a household name has little
reason to launch a marketing campaign to make
themselves look better than they are to investors.
They already have plenty of people willing to invest
in their stock. Low-capitalization stocks are quite
different. Oftentimes the promoters of these small
issues will make a deal, however tenuous, with a
major company as a way to boost the reputation of
the penny stock company. Any link to a major
corporation is seen as a sign of trust, and it can
lead to more investors willing to purchase the penny
stock.
The problem is that in many cases when some deal or
cooperation between a major company and a penny
stock company is announced it is overblown and made
to look much bigger than it actually is. In many
cases when such a deal is announced it is often a
good time to sell the stock on the resulting rally
because once investors realize that the deal isn’t
so big as promoted the stock will soon sink back to
prior levels. This can also happen with regular
stocks when they announce a new technological
development, partnership, or product, but typically
there is no exaggeration of the deal and any
resulting rally will typically stick.
Penny stocks can be scams
Because they have a smaller number of outstanding
shares and are typically quite illiquid, shares of
penny stocks are far more likely to become the
target of manipulation. Some of these stocks are
even launched with the intent to create some sort of
scam that lures investors in, makes the founders
rich, and then the stock falls into oblivion.
Investment fraud is well known to be more common
with penny stocks, where the low trading levels make
them easy to manipulate.
Penny Stocks are for Speculation
Buying the right penny stock at the right time can
lead to a huge windfall, but the odds of seeing
returns in the hundreds or even thousands of percent
are diminishingly small. OTC stocks are inevitable
far riskier when compared with regular stocks. Often
penny stocks are involved in some venture that is
unlikely, such as development of a new medicine or
technology, or searching for oil or mineral
deposits. This makes the stocks more of a gamble
since there’s a component of luck involved in the
performance of the underlying company. Of course,
some luck is also involved when large, established
companies are considered, but this luck is a far
smaller component in the overall performance of the
stock.
Penny stocks also suffer from being far less liquid
than regular stocks. Because of this you might find
that it’s impossible to sell a penny stock when you
want to. You can also see much greater volatility in
the price of penny stocks as any small news can
cause a penny stock to rise or fall dramatically.
More liquid regular stocks have greater price
stability, and it is unlikely you won’t be able to
find a buyer when you’re ready to sell.
Whenever you do choose to speculate on penny stocks a
good rule of thumb is to take some profits whenever
the stock rises. Ultimately if you can recoup your
initial investment then any stocks you still own are
essentially “free”. Of course, the same
strategy can also work with regular stocks, but
typically it isn’t as necessary since the larger
stocks that trade on the regular stock exchanges are
far less volatile. Here’s Nexioval’s
personal selection of top
Stocks to trade.
Ultimately these larger stocks should make up the
bulk of any traders’ holdings, with the smaller and
more volatile penny stocks relegated to a small
portion of the diversified portfolio. Because penny
stocks are so speculative, they should only be
purchased with money that you can afford to lose.
In Conclusion
When choosing between regular stocks and penny stocks
it is crucial to remember that regular stocks of
well-known companies are for investing, and they
should make up the bulk of any portfolio. OTC stocks
are speculative, and should be handled as such, with
them making up just a small portion of any
portfolio. Regular stocks will hopefully
provide steady and stable growth in the long term.
Penny stocks are for making quick profits in the short
term. Both have a place in any portfolio,
but the risk factor in penny stocks needs to be
remembered.