What are penny stocks?
Stocks trading at less than $5 per share are referred to as penny stocks. Many penny stocks generally trade in the OTC or over-the-counter market, while some trade on the NYSE and NASDAQ as well.
Penny stocks are sometimes interchangeably called micro-cap stocks, which are stocks of companies with a market capitalization of $50 million $300 million (generally stocks with a market cap of below $50 million are called nano-cap stocks).
How penny stocks differ from other stocks?
Several investors get attracted to penny stocks because their low share prices appear like bargains and even a small upside in the absolute value of the stock price translates into a huge gain in terms of percentage returns. Unlike regular stocks, penny stocks often trade over-the-counter as larger exchanges like NYSE and NASDAQ have more stringent disclosure and listing requirements, like the minimum share price condition.
Investors need to be aware of the fact that penny stocks are generally quite speculative, have lower liquidity and higher risk compared to stocks of established companies with higher market cap trading on larger exchanges.
How to find the best penny stocks?
Once an investor sets an investment objective and understands his risk appetite, he can use various investment tools to find out the penny stocks that align with his risk-reward profile. The TipRanks Penny Stock Screener tool can help you narrow down your research to a few stocks based on several criteria like market cap, upside potential in the stock, the sector that you prefer to invest in, Wall Street’s analyst consensus, investor sentiment, and news sentiment.
In the example below, we attempted to find micro-cap stocks, which have an upside potential of over 20% coupled with a Strong Buy analyst consensus and having positive investor sentiment in the healthcare sector. We also narrowed the search to stocks carrying TipRanks Smart Score of 8-10.
The Stock Screener in this case displayed two stocks based on the conditions specified. So now we should dive deeper and try to know more information about these companies, like is the company in the growth phase and is relatively new or has it fallen to the penny stock status following setbacks, check the fundamentals of the company and its growth prospects, recent news, trading volumes (to check liquidity) and any information on potential stock dilution through additional stock offerings or other tools like stock splits and employee stock options.
Top penny stocks for 2021
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* Data update (10.05.21)
What are the pros and cons of penny stocks?
Through penny stocks, small companies can raise capital.
Penny stocks have the potential to generate significantly high returns.
Even with a small amount of capital, investors can gain exposure to penny stocks of companies with phenomenal growth potential. Monster Beverage is a great example of a penny stock that emerged as a well-established large-cap stock.
Penny stocks are usually thinly traded and low liquidity might make it difficult for investors to sell their shares when they desire to do so. Lower liquidity than regular stocks leads to a higher bid-ask spread for penny stocks, which could result in a higher cost of trading.
It is often difficult to assess penny stocks especially when they are new and have no or limited track record or when adequate information on the company’s financials is not available to enable a proper evaluation. They are often highly volatile.
What makes penny stocks risky?
Aside from the disadvantages discussed above, the major risk associated with penny stocks is that they are prone to manipulation and fraud. Owing to less stringent disclosure requirements associated with OTC-traded penny stocks, investors are highly vulnerable to “pump and dump” schemes. Under such fraudulent schemes, promoters first try to boost the stock price with false or misleading statements about the company and then dump the stock at an inflated price.
Investors should be aware of the possibility that they could lose their entire investment through low-quality penny stocks.
Investing in penny stocks warrants extra caution and therefore investors should certainly conduct due diligence about the company’s fundamentals and other key aspects before going ahead. It is crucial to be aware of the high risks associated with penny stocks before blindly investing based on high potential rewards.