#TBT: The 4 Biggest Lies About Penny Stocks (That Make Them Sound Good)
"Make millions in just days trading on the OTC markets!"
"This company is the next Microsoft, I guarantee it!"
"It just takes a thousand dollars to get started, and next week you'll be on the beach!"
I shouldn't have to tell you that if something sounds too good to be true, then it IS too good to be true. Unfortunately, these lines still work on millions of potential investors and I've witnessed firsthand the heartache it causes for so many. If you've seen The Wolf of Wall Street, you know how much money can be made off uneducated people with just the promise for potential returns. It's important to note that these individuals did not recommend anything in the Dow Jones Industrial Average, but rather kept the focus on penny stocks, suggesting that they had to buy now to profit from growth in the near future.
Many tactics are used by sales guys and financial advisors to get you to buy into penny stocks after first luring you in with stable stocks that you already recognize and know. Maybe you ARE one of those people who does their research on any and all penny stocks, but most investors just do not have the time. How do you know if you're being duped into buying penny stocks? Here are the four biggest lies used to get you into this mess:
1) "It's not a 'penny' stock, it's a 'micro-cap' stock."
This is merely a fancy way of saying the exact same thing -- very few stocks whose market capitalization is below $100 million have a stock price that is more than $10 per share. Generally, low market caps - or micro caps - ARE penny stocks. If the company made more money over time, you would expect that its stock price would also improve. Salesmen will be aghast if you throw this back in their face, and won't have any idea what to say.
2) "These stocks are so easy to buy that anyone can do it."
Anyone who understands the stock market - or any market for that matter - knows that you must have someone willing to buy what you have to sell. The trouble with most penny stocks is that buyers and sellers are few and far between. And this is where liquidity is an issue: one investor has the ability to move the stock 100% higher just by making a purchase of a few thousand shares, and this artificially inflates the price of the stock. I always tell my friends that if the stock simply does not trade (i.e. no more than 100,000 average shares traded per day) then it is worth avoiding. If you ever went to sell those shares, you will have a hard time getting rid of them because you, like all the other investors, will try to find ANYONE to buy them.
3) "You have to buy now, otherwise you'll miss your chance at a HUGE rally. Then you'll be too late."
If the stock truly is a growth stock, and will continue to rise over the long term, you can buy it any time the market pulls back and you can still make a lot of money. There is no time sensitive issue in making money on stocks unless you happen to be a day trader and that is all that you do. For day traders, timing is everything. For everyone else, it really does not matter when you buy a stock. Additionally, look at the performance of most penny stocks - on an average day, the stock will either have extremely wild swings, or it will never move. If it never moves, sweetheart, you're not missing anything.
4) "Did you know that Microsoft AND Walmart were once penny stocks? Look at them now!"
While some may have good intentions with this line, I'm here to point out that this statement is actually false. Companies that want to be publicly traded must first raise cash from private investors until they can prove that their growth makes an IPO (or an initial public offering) for their stock worthwhile. There are thousands of venture capitalists, private equity firms and commercial banks looking for good companies in which to invest, and generally the companies with the best growth potential and the best reputations are able to raise money from them.
Neither Microsoft, nor Walmart, were ever penny stocks and a simple search on Google will show you that Microsoft IPO happened in 1986 and its shares were priced at $25.50, while Walmart's IPO in 1970 priced shares at $16.50 -- either started on the public markets below $10 per share.
However, there are certainly cases of large, publicly traded companies that find their stock priced under a dollar over time. During the Great Recession, investors were able to buy shares of Citigroup, Office Depot, Ruby Tuesday and Zales all below or around $1 per share. It's important to note, that this was an extraordinary time and very few people felt comfortable buying stocks anyway.
It's important to note that none of these were really TRUE penny stocks. True penny stocks are listed on the OTC market and are issued by companies with no track record and extremely low liquidity. The majority of these stocks will never make it onto the big boards, and most are doomed to run out of money before ever hitting the big time. Do you research, ALWAYS! Perhaps there are small stocks that you understand, and that is fine, but do not fall for these sales pitches.