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Several years ago, my friend from college had the chance to work for an up-and-coming tech startup in NYC.
She was just an intern at the time, but she had the chance to dip her feet into the startup world and learn the ins and outs of starting a new business. It was a super exciting time for her!
As the business grew in success, they decided to go public and offer stock to investors. The stock started out very inexpensive, around 50¢. They secured several investors who bought tons of shares, and began building on a great foundation for their future.
These stocks that they first offered weren’t available on the stock market, and I was interested to learn how and why they were bought and sold.
I dove into the world of penny stocks to learn all about these low priced stocks that I first heard of from my college friend.
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What are Penny Stocks?
When you think penny stocks, think startups. Like I mentioned, penny stocks are “cheap” stocks that offer opportunity to buy into a smaller or newer company that’s just starting to be publicly traded. It’s a great way for a new company to get some funding and buy-in with investors.
Especially if there’s any hype surrounding the startup, this can help investors get excited about cheaper stock prices and the potential for future earnings.
Let’s bust some myths. Are penny stocks really just a penny? Sadly, no. But they are very inexpensive!
The typical stock that falls into this category is under $5. They are sometimes traded on the stock market, but they usually have a more unique way of being bought and sold. Let’s get into how you could potentially purchase penny stocks.
How Can I Invest in Penny Stocks?
Penny stocks are traded both on the stock market and, typically, the OTC market. This stands for over the counter. If you’re confused and picturing buying your medicines over the counter and wondering how that can be done, have no fear.
These purchases are ordered through brokers who communicate with each other either online or over the phone to buy and sell these smaller stocks.
This market isn’t quite as accessible and updated as the stock market, but there are several platforms on which you can buy, track, and sell penny stocks over the counter through a broker.
Now that you know how these unique stocks are traded, let’s talk pros and cons. Here are some reasons you may or may not want to start investing in penny stocks:
Pros
- They usually include smaller companies
Typically, when you purchase a stock that isn’t worth much, it might be because the company is smaller, and doesn’t have as much revenue as, say, a Fortune 500 company. This can provide the potential for the smaller company to grow in the future, and these stocks might give you a great reward by the time you sell them.
- They are inexpensive
This is kind of a given, but penny stocks are way less expensive than your typical price for a share of stock. You can purchase several shares for under $20. This is a great option if you want to invest recreationally, and learn the market with a limited amount of money.
- Costs can be much lower
Because penny stocks are typically traded over the counter, your broker won’t charge you astronomical fees to buy and sell, since you wouldn’t make anything if they did. The costs will vary broker to broker and transaction to transaction, so make sure you’re aware of the fees before you jump in.
- You might get a huge payout
If you invest in a new company early, you could rise to success with them as an investor. Maybe you purchase the stock when it’s a few cents and sell years down the road when the company has become wildly successful. This is a possibility with penny stocks!
Cons
- They might not be easily sold
These types of stock are not as “liquid” as others, meaning they can’t always be easily sold due to lack of demand. Since stocks are bought and sold based on supply and demand, if you want to sell one of these lesser known stocks, it might not always be possible if there aren’t enough investors interested in the stock. This kind of ties up your money and can be bad news for your investment.
- They usually include smaller companies
Yes, you read that right! This aspect of penny stocks can be a pro and a con. Because the companies selling penny stocks are smaller, they might not be successful, and they might not have the resources to be successful like a larger company might.
- They are associated with high risk
Because these stocks are usually from new and smaller companies, they can present huge risks. Did you know that 45% of new businesses fail within 5 years of opening their doors? This figure represents the huge risk that new companies pose for investors.
- You might not be able to do your research
What do I mean by this? Well, since penny stocks are from smaller companies, they might not have as much history of finances and operations available to the public, like bigger companies do. This can cause less investor confidence when you buy into these smaller stocks.
Currently, a company headquartered out of Israel called ReWalk Robotics is hot in the world of penny stocks. It rose to fame on social media, and many investors have been buying in due to the hype and low priced shares.
The shares were sold at 87¢ and now they’re up to $1.73 a year and a half later.
Investors have started buying in due to the rise in fame and their interesting technology that assists those with impairments with robotic exoskeletons. Because the company is still fairly new and small, their share prices are low but their future is still unknown.
But if you invested a few thousand dollars in these penny stocks a year ago, you could be rolling in the dough!
Are Penny Stocks Worth it in The Long Term?
As you can tell, I have quite a few more items in my “Cons” list than in the “Pros” section. In the long run, it seems like these stocks are heavy on the risk and light on the information. I’m a big fan of extremely informed investing, and because of this I don’t typically include penny stocks in my long term investment portfolio.
If you have a high tolerance for risk and want to allocate a small portion of your funds that will be invested for a long period of time towards penny stocks, it might be highly lucrative for you when you cash out your long-term investment if you choose the right penny stocks.
The key is choosing the right one! And with limited information on the companies associated with these stocks, this can be tricky. There are manyrisks that come along with penny stocks, however confident you may be in a new company.
I certainly had faith that my friend’s company would make it far, and I actually do wish I had invested back in college!
Now, the startup she worked for back then is a multi-million dollar company that is doing exceedingly well. With great risk sometimes comes great reward. There are definitely success stories when it comes to penny stocks, but there are also many risks to consider before diving in.
