The potential rewards are enormous. In fact, pennies have been the best performers lately. Over the past 30 days, Quantum (NYSE: QTM), Timberline Resources (AMEX: TLR), and EntreMed (Nasdaq: ENMD) are all up anywhere from 80% to 100%.
Those quick doubles look like easy gains, considering that Priceline (Nasdaq: PCLN) and IBM (NYSE: IBM) would need to add $170 and $120, respectively, to their share prices to do the same.
Everybody loves pennies
It's the potential of quick gains in "cheap" stocks that keeps investors coming back. We typed "penny stocks" into Google,
and the search engine spat out "about 1,680,000" hits. We did the same
for more time-tested terms such as "blue-chip stocks" and "dividend
stocks" -- the terms folks should be searching for in a bear market
like this -- and got just 181,000 and 596,000 hits, respectively.
Sure, we expected a discrepancy, but the size of the gap was
startling. It became even more interesting when we broke down those
hits with Google Trends. According to Trends, penny stocks are
particularly alluring to investors in Tampa, Miami, and Orlando -- the
locales where the term is most often searched.
We hope the folks Googling "penny stocks" down there aren't retirees trying to cope with this crazy, crazy market.
This stock is set to take off! Or not.
According
to the Securities and Exchange Commission, the term "penny stock"
generally refers to low-priced (below $5), speculative securities of
very small companies. To quote the SEC: "Investors in penny stocks should be prepared for the possibility that they may lose their whole investment." (It's worth noting that the emphasis in that last sentence is in the original.)
Pay attention to the SEC's entire definition, not just the stock
price. Going solely on price would wrongly categorize billion-dollar
companies such as Regions Financial (NYSE: RF) as penny stocks.
Regardless, the SEC is spot-on when it says that true penny stocks are among the surest ways to lose money in the stock market.
Well, then, why do we love penny stocks?
We
love penny stocks because they're fascinating. The world of pennies is
inhabited by hardworking average Joes and Janes hoping to strike it
rich, as well as by pumpers and dumpers, hypesters, and scammers. In
pennies, the logic and reason that applies in the rest of daily life is
replaced by zeal and prayer.
However, we don't love them enough to actually buy them. Yes, they
have big potential, but their daily gyrations are unpredictable -- the
stock-price movements have next to nothing to do with the underlying
company the stock represents. In fact, trading in pennies is highly
illiquid, and prices are often manipulated by forces not at all related
to the business.
The dangers of incredible promises
If
you're buying stocks without paying attention to the businesses you're
buying, then you might as well be buying a lottery ticket. Or, to use
another analogy, you might as well buy up every baseball card of a
benchwarmer on the Akron Aeros Class AA baseball team and hope that he
someday rises up, fulfills his potential, and becomes an all-star for
the big-league Cleveland Indians.
There's a better way
Before
you start saying the rest of the stock market is boring -- though
you're probably not saying that any longer -- let us introduce you to
some underfollowed small caps. They're nothing like penny stocks, yet
they still offer some of the best returns in the market. Unlike penny stocks, promising small caps:
- File reliable financial statements.
- Are transparent.
- Have conference calls that individual investors can listen to.
- Don't simply hype their stock in press releases.
That's a starting point. There are more -- and more important --
criteria to help you find great small-cap companies. Our team at Motley Fool Hidden Gems,
for instance, looks for a balance sheet with lots of cash and no debt,
and a tenured CEO (or founder, if possible) who holds a substantial
ownership stake in the business. In other words, we're looking for big
returns with good old-fashioned bottom-up analysis.
© 2009 UCLICK, L.L.C.
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