Penny stocks, more formally known as small-cap stocks, are shares in a company that usually has a market capitalization of less than $300 million. Small-cap stocks, which are another type of penny stock, are issued by companies that typically have a market capitalization of under $50 million. Penny stocks usually trade for less than $5 per share.
Definition and Examples of Penny Stocks
Penny stocks are considered to be those shares that typically trade for less than $5 per share. If a company has a market capitalization of less than $300 million, it is generally regarded as a penny stock.
For example, in February 2020, Eastside Distilling (EAST), a beverage manufacturing company in Portland, Oregon, was trading at around $2 per share, with a market capitalization of approximately $21 million. Due to its market capitalization and share price, it could be classified as a penny stock.
How Penny Stocks Work
Some investors are attracted to penny stocks because of their low price, allowing them to purchase a large number of shares. However, the low price also opens the door to significant fluctuations in value, creating opportunities for substantial gains or substantial losses.
The characteristics that make a penny stock a penny stock also make it a riskier investment compared to larger company stocks.
Advantages and Disadvantages of Penny Stocks
Advantages:
- Stocks are affordably priced
- Potential for significant value increases in a short period
- Can be traded with most brokerage firms
Disadvantages:
- There is often less public information available about the company
- Unstable price
- Low liquidity, which means it can be challenging to sell
- More susceptible to price manipulation through fraudulent activities or other practices
- Subject to lower standards and oversight than companies trading on major exchanges
Where Penny Stocks Trade
Although some penny stocks trade on major exchanges like the New York Stock Exchange (NYSE) or NASDAQ, many penny stocks trade on the over-the-counter (OTC) market. You can find penny stock prices on a site like OTC Markets, which provides information on nearly 12,000 securities traded on three markets.
OTC Markets also provides news and research capabilities for penny stocks, including a stock screener that searches based on criteria you set, such as past performance, country, and industry.
Penny Stocks vs. Small-Cap Stocks
Investors need to be clear about the key differences between penny stocks and small-cap stocks. Penny stocks are generally riskier and more susceptible to price manipulation than small-cap stocks that are traded on major exchanges. Penny stocks are usually associated with companies that have a market capitalization of less than $300 million, while small-cap stocks are typically associated with companies that have a market capitalization up to $2 billion.
Penny Stocks Small-Cap Stocks
- Trade on the over-the-counter market. Most trade on major exchanges.
- Not subject to the same regulations and oversight by the main securities and exchange commission. If listed on a major exchange, they must provide regular financial reports to the main securities and exchange commission.
- Cost less than $5 per share and may cost less than $1. May cost more than $5 per share.
- Susceptible to price manipulation through fraudulent activities. Less susceptible to price manipulation, although not completely protected from it.
Companies that list their shares on the over-the-counter market often do not have to provide the same reports that stocks listed on major exchanges are required to submit to the main securities and exchange commission. However, many small companies provide reports to the main securities and exchange commission that include information about financial, managerial, and other details.
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You can obtain information about small company stocks from the company itself or from the state securities regulator. The American Society of Securities Administrators can provide information on how to contact the securities regulator in your state.
Note: Investors working with a securities broker or investment advisor can ask if the small company they are interested in has filed a report with the main securities and exchange commission. You can also conduct your own research on the main securities and exchange commission’s website or through your online broker.
Precautions to Take Before Investing in Penny Stocks
It is wise to take precautions before investing in any company. With penny stocks, it is essential to take precautions doubly. Before buying shares, research the companies through your broker, or through the main securities and exchange commission’s website, or through online screening services (which may require a subscription), or anywhere else to find the following information:
- How the company makes money
- The company’s management and directors
- Whether trading in the stock has been suspended (available on the securities commission’s trading comments lists)
- The background and registration status of any company or advisor providing unsolicited recommendations about stocks (using the SEC’s Investment Advisor Public Disclosure database)
Note: A penny stock that sees a sharp increase in price or trading volume without a clear reason should be a red flag that price manipulation may be occurring.
Every investor at some point may hear the principle “high risk, high reward.” The more you know about the penny stocks you wish to invest in, the more likely you are to experience the positive side of this equation.
How to Buy Penny Stocks
If you are considering buying penny stocks despite the risks, you can do so through most online securities brokers. Some brokers may place restrictions on these transactions in an attempt to protect investors. Do the necessary research before trading penny stocks to ensure you understand all the risks involved.
Another thing to consider when investing in penny stocks is how much in fees you will pay to the broker. If the fees you pay are high, they may negate the profits you achieve from your penny stock investments. Check brokers like Charles Schwab or Fidelity for trading penny stocks.
Takeaway
Penny stocks, also known as small company stocks, refer to stocks that typically trade for less than $5 per share, and the company usually has a market capitalization of less than $300 million. Penny stocks typically do not trade on major exchanges like the New York Stock Exchange (NYSE); instead, they trade on the over-the-counter (OTC) market, which can be accessed via sites like OTC Markets. Penny stocks are considered riskier investments and more susceptible to price manipulation than other stocks, but they have the potential for significant value increases in a short period. Investors should be cautious and take the necessary precautions before investing in penny stocks and should understand all associated risks.
Source: https://www.thebalancemoney.com:443/what-is-a-penny-stock-5114192
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