Are Penny Stocks a Good Investment Option?
By Acceler8now.com Stock Investing Team, November, 2007
Penny stocks could be seen as sought-after investment opportunities or high-risk, no-go stocks, and that depends on the psychology and bent of the investor. There are investors that find a goldmine in those stocks and would invest a lot of effort scrutinising for potential profit opportunities. Yet, at the other extreme, are those who cannot stomach the risk and loss potentials of such stocks. In the face of these extreme positions, how should you view penny stocks as a possible investment option? This article is to weigh the issues and present factors that can help you take a position, especially in the Nigerian context.
But, What Are Penny Stocks?
Penny stocks are basically the low-priced stocks that occupy the bottom rung of the price ladder in the stock market. They are stocks that the market has not found any good basis to price up and so they remain in the price range of N1 - N5 per share. This price range is not official, and it's possible to find those that would consider stocks below N10 as penny stocks. They are generally stocks of low-capitalised companies, which is why they are also called micro-cap or small cap stocks. Strictly, micro-cap or small-cap refers to the total capitalisation of the company while the penny tag captures the low market price of the stock. The terms are however easily interchanged.
Key Attraction of Penny Stocks
Ordinarily, everybody would love to own the high-priced stocks of blue-chip companies. Why penny stocks?
Firstly, there is the strong argument of the relative ease of substantial price appreciation (and depreciation too!), possible with penny stocks. Take an easy illustration. Nestle Nigeria Plc could easily appreciate by N15 over a bullish week. At its current price of N210 (29/10/2007), that would amount to just a 7.12% price gain. If, however, a Staco Insurance Plc with current price of N2.25 inches up by a mere N1.00, that easily amounts to an appreciation of 44.44%. Penny stock investors reason that, in a relative sense, it's easier to achieve massive capital growth in penny stocks. It must be said, though, that losses are equally as easy.
Secondly, it is a fact that certain stocks are really at price levels that can be considered out of the reach of small investors. While a tiny 200 units of Nestle Nigeria would require N42,000 at today's price - not an easy amount for many possible investors - that same quantity of Staco would take only N450 to acquire. Not a ground-breaking investment, by any chance, but if careful selections are made, a low-income earner could easily set himself on the path to financial growth by picking such affordable investments.
Land-mines to Watch
The key reservation about penny stocks is the their risk index which is usually quite high. Every investment has a risk factor to it, but penny stocks entail a much higher exposure. The reasons can be summarised:
- Poor Information
One, they are usually stocks of small under-reported companies. Some, in the Nigerian context, would be found in the second-tier listing, where regulatory requirements for listing and post-listing reporting are moderated. Others may be fringe companies on which public focus and searchlight stay minimised. Some could be relatively new companies without much track record or old companies that have gone off the limelight due to protracted unimpressive returns or other operational setbacks. That, invariably means more risk of walking into a land-mine.
- Illiquidity
Liquidity concerns are also higher. There are blue-chip stocks you can be sure of selling when you want, because somebody will be there to pick them. Not so, with any certainty, when it comes to penny stocks. You could be stuck with it, at least at the time you want to sell and that could be a major problem. Penny stocks are relatively less liquid.
- Inherent Weaknesses
When a stock crawls within the N1 to N3 range or thereabout in a market that trades some other stocks for over N100, it logically raises questions about inherent weaknesses or capacity constraints. You can trust that if the market judges a company as having the capacity to generate healthy earnings and pay good returns to investors, it will snap up it's stock and in the process push up the price. There must be a reason for the market to price a stock in the penny region. To find gold in such stock, you need some good homework.
 Make a Killing in Penny Stocks?
All said, penny stocks could just be viewed as a heady blend of high risk and strong profit possibilities. That wouldn't mean that every penny stock offers solid potentials for capital growth. Some may never rise beyond where you find them and could indeed slide heavily. But great opportunities could yet be found in such stocks, if you succeed in spotting the hidden gems.
Finding the Gems
Clearly, investing in penny stocks requires careful evaluation to identify truly viable ones. That demands proper researching the companies to find where there is hidden value that can engender capital growth. If you are looking to invest in penny stocks, one sector to scrutinise for opportunities at this time may be the insurance sector. With the sizeable injection of capital into that sector, some well-managed companies may find their rhythm and easily break out of the penny range where most are, at the moment. Investing in penny stocks is an option, but always consider the inherent risks.
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