Breaking: Charger will also no longer come with newsletter 🔌 (Penny Stocks)
Congratulations! 🏅 You made it through another week of October.
This week was jammed with the usual: no stimulus, more unemployment, vaccine talk, earnings, you get the picture. We highlighted the most interesting stories of the week below and dive into the one thing Robinhood users get for free when they open an account (and are probably too afraid to admit they have no idea what to do with it): Penny Stocks.
This Week’s Biggest Headlines
- Johnson & Johnson pumped the brakes on its COVID vaccine trials after a participant developed an “unexplained illness.” While this is rather common for vaccine trials in general, it’s still a major setback for the pharmaceutical company – and the rest of the world – as Johnson & Johnson was one of the main frontrunners for bringing a vaccine to market. Read more.
- It has officially arrived, and no we’re not referring to the new iPhone. The second wave of COVID-19 has hit Europe, surpassing the U.S. on daily cases and London and other parts of the UK are officially on high alert for the virus. Major cities across Europe have imposed curfews in order to manage the spread, concerning many analysts that this will thrust the EU back into a recession. Read more.
- Seriously though, the new iPhone did arrive this week. In fact, there were four: the iPhone 12, iPhone 12 Mini, iPhone 12 Pro and iPhone 12 Pro Max. Fun fact: the iPhone 12 Pro actually has 7 cameras. 🤥
The new design pays homage to the boxy iPhone 5, which we have heard many very intelligent people believe was their best design to date. People are scratching their heads over one change, though: no headphones or chargers will be included. Samsung was quick to mock Apple for the move, which is totally fair. Read more.
- The stock market fell for the third straight day this week. What looked like a solid month has quickly turned sour, and for a variety of reasons. With COVID-19 cases rising across Europe, an economic stimulus deal that has yet to materialize, and more uncertainty around the COVID-19 vaccine timeline, market volatility was inevitable. Read more.
- Disney has restructured its media and entertainment division to double down on streaming. On the heels of a less than stellar year, Disney has taken the L across nearly every aspect of its business. Theme parks are closed across the globe (with the exception of a few, including Disney World in Orlando). Cruises are still shut down. And do you remember when The Last Dancebecame ESPN’s biggest draw because there were no live sports to show? Check out this depressing visual that would bring any Disney exec to tears:
- The only major success seen was with Disney+, which now has over 60 million subscribers less than a year after launching. The pivot makes sense, and considering Disney+ will be the platform for Hocus Pocus 2, we have no qualms with production going into full force. 😈 Read more.
Even Lebron winning another ring couldn’t reel in viewers ⛹️
The pandemic has claimed a lot: millions of jobs, hugs, indoor dining, socializing, politely smiling to strangers, and for a while – live sports. Many assumed that once sports returned, viewership would go through the roof. It makes total sense; people are at home and fans lamented over how much they missed watching their favorite teams compete. However, that wasn’t the case.
According to Sports Media Watch, live sports had record low viewership across the board.
- The 2020 Stanley Cup Playoffs had a 38% decrease compared to last year
- The finals of golf’s U.S. Open had the lowest viewership and ratings out of all tournament finals ever held
- Game 1 and Game 2 of the ACLS set the record for the 2 least-watched LCS games
And lastly, the Los Angeles Lakers, arguably one of the biggest NBA franchises, won the NBA Finals on Sunday. They also won the less coveted title of “least-watched NBA Finals on record.” 🏆
There’s no doubt that the main culprit is the pandemic. This rings especially true when you consider just how much schedules had shifted in order to accommodate the months-long shutdown (NBA finals in October? Unheard of). And with a parsed down, and often hard to follow playoff format, the March Madness-like elimination rounds led to a short-lived euphoria of our favorite leagues finally resuming. A classic case of expectations missing reality.
Clearly, people like routines. When you look at these numbers, it’s hard to argue against that. Looks like we’re not so different from cats after all. 🐈
Penny stocks are stocks that provide the issuing company (typically a small-cap organization) with the ability to raise capital without meeting the stringent requirements of large exchanges. As with “regular” stocks, penny securities are created through an IPO, although the company doesn’t always have to file a registration with the SEC.
Typically, penny stocks trade over-the-counter rather than on large exchanges, although there are a few penny stocks (as well as “low price” securities) that trade on nationwide exchanges, such as the NYSE and Nasdaq.
An Introduction to Penny Stocks
Not every investor has the money or inclination to invest in large, well-established companies that will eventually provide gains. Some may be looking for short-term explosive growth; others may just want to see any return on investment in a few months, rather than waiting out the market. This is where penny stocks come into play.
Penny stocks, also known as microcap stocks, are stocks offered by a small company for less than $5 per share. Most investors like penny stocks because they have a high potential for sudden and explosive growth that leads to high return on investment (ROI).
However, these returns are not guaranteed. In fact, a result of the fundamental makeup of penny stocks, they’re considered “speculative” – investments that carry a high risk. This risk is often equivalent to or greater than their growth potential – which is why it’s essential to understand penny stocks before you invest.
Explaining Penny Stocks
The term “penny stock” used to apply to stocks that traded for less than one dollar apiece – hence the name, as these stocks traded for literally pennies. However, the SEC (Securities and Exchange Commission) has since adjusted the definition to any stock trading at five dollars or less per share.
The purpose of a penny stock is to provide small companies with a way to raise capital via public funding. This move is often the first big step for small companies growing in their industry and can provide the impetus needed for smaller players to build their presence with the public.
Other things to note
- Companies create penny stocks through the IPO, or initial public offering, process – just like larger companies
- They are required to follow all applicable securities laws in the state or country in which they list
- Furthermore, before going public, the company must register with the SEC or explain why they’re exempt from registering
Once a company has been approved to trade penny stocks, the company can apply to list with various boards and exchanges. Typically, penny stocks trade through over the counter (OTC) transactions via the OTC Bulletin Board (OTCBB) or Pink Sheets (a private trading board).
However, some companies may offer penny stocks in private transactions as well. Furthermore, a few penny stocks meet the listing requirements for exchanges such as New York Stock Exchange (NYSE) or the Nasdaq and are traded on par with the big guys.
Due to the lax process and requirements for listing penny stocks, they can come with high risks to offset their potential for rewards. Understanding these risks is paramount to successfully selecting a “winner” in the penny stocks game.
The Risks of Penny Stocks
For the most part, penny stocks are issued by smaller or newer companies. Therefore, one of their hallmarks is the fact they frequently have both low liquidity and low buyer numbers, which leads to infrequent trades.
Penny stocks are also more volatile than securities offered by larger companies. It’s easy to see why, too: a $4 move on a $5 penny stock is a much bigger deal than a $4 move on Amazon’s shares. Furthermore, as investors frequently purchase penny stocks in bulk, large orders by a single individual can drastically increase or drop the price on a dime.
Additionally, as penny stocks are also available for after-hours trading, the volatility does not end at the close of the trading day. Some investors prefer to wait until after-hours trades due to the potential for selling shares at unusually high prices (or buying them at extraordinarily low prices).
However, due to the aforementioned limited liquidity and interest, investors may be unable to find a buyer – or a fair price – when it comes time to shed their investment.
There are a few other risks associated with penny stocks that are not usually present (or at least not as prevalent) in larger stocks.
Some of these include:
- Wide bid-ask spreads (large price quote variations)
- Lack of legally mandated public information
- No minimum requirements to list on a trading board
- High fraud potential
Additionally, many penny stocks are issued by either smaller companies or large companies that have a poor track record. Some of these companies may be heading for bankruptcy, while others may list penny stocks under false pretenses in an attempt to grow their capital.
Therefore, as a rule, penny stocks are best suited for investors with a higher risk tolerance. This group is typically defined as younger investors (or investors with deep pockets).
Many advisors also recommend that, regardless of financial status, investors place a “stop-loss order” with their broker. The purpose of this decree is to automatically sell a particular security when the price drops below a specified threshold. This move minimizes both loss and risk for investors.
When is a Company Not a Penny Stock?
In order to be a penny stock, a company must meet certain criteria, such as shareholder equity and market capitalization in addition to price.
Securities on a national stock exchange are typically exempt from designation as a penny stock, in large part because securities on large exchanges are thought to be more resistant to manipulation and fraud.
Therefore, when stocks crashed in 2008, and again during the 2020 pandemic market, large companies that fell below the $5 threshold were not reclassified as “penny stocks.” Instead, these companies were labeled “low price securities.”
Different Types of Penny Stocks
There are three main ways to differentiate and research penny stocks that the average investor should be aware of. While these are not “official” classifications, they provide a basic framework for examining the penny stock market.
Solid Business Structure and Fundamentals
Examining a company’s business structure and their financial fundamentals is a good way to get a feel for the organization and growth potential.
- A solid business structure and potential for growth can outweigh some of the risks
- If companies offer little to no information, or all of the information that is available makes you balk, you should be wary of investing your capital
- Companies with a history of low financial metrics plus low growth are rarely a good buy, as their room for expansion is overshadowed by poor performance
- On the other hand, if a company currently has so-so numbers but a history of upward momentum, the stock may be ready to make that coveted price leap
High Volume Penny Stocks
Some penny stocks are historically known for their high-volume trades.
- While this is one of the reasons penny stocks are volatile, it’s also part of what makes them so profitable
- Furthermore, if a penny stock has a history of trading on larger volumes, it will be easier for an investor to find a buyer when they’re ready to get out
High Volatility Penny Stocks
Whether you’ve been in the game for years or are just getting started, knowing any security’s volatility and price history is important before buying in.
- As a rule, stocks with stable prices are low-volatility, while stocks with erratic leaps are high-volatility
- While volatility can be dangerous, it can also reap large rewards
- The key to investing based on volatility is to consider whether the stock in question has a general history of upward trends or sudden leaps, rather than a history riddled with extreme dips and only moderate gains
Why People Invest in Penny Stocks
With all of the risks and potential for manipulation inherent in the penny stock market, some people may be asking – why would anyone want to invest?
The answer is actually the same as to the question of why investors wouldn’t want to invest in them: their volatility.
Because penny stocks are prone to such large leaps overnight or in a matter of weeks, many investors believe that by choosing the right stock at the right time, they can cash in on sudden gains. While companies rarely make a sudden leap from penny stocks to “normal” stocks, it’s happened before – and the investors who rode the wave to the top made a pretty penny doing so.
However, success in penny stocks involves choosing the right one, and sometimes holding out through drastic dips that make normal investors quake with fear. Once more, its recommended that investors don’t dive into penny stocks unless they have a higher risk tolerance.
The Bottom Line?
Penny stocks are known for the volatility and high risk, as well as for their potential for high reward. It’s usually advised an investor be in a high risk tolerance bracket to invest. However, if an individual believes that they can stomach losing everything they invest in penny stocks, there can be massive financial gains to be made.
The Devil’s Financial Dictionary, a book about investing written by investors for investors – and anyone looking for a good laugh. It’s clear that the author, Jason Zweig, who penned the modern adaptation of The Intelligent Investor, has a way with words, in the form of brutal honesty, sarcasm, and “smart humor.” Robert J. Shiller, finance professor at Yale and Nobel laureate in economics, considers the book “the most amusing presentation of principles of finance [he has] ever seen.”