3637: What is a Penny Stock? by Jeff Rose of Good Financial Cents on Stock Market Education

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[00:00:56] This is Optimal Finance Daily. What is a penny stock? By Jeff Rose of goodfinancialcents.com. Being employed in the securities industry has its fair share of unique and challenging situations. One situation that I always find comical is when a client calls me and wants to buy some obscure penny stock that they claim is the next sure thing. Each time this occurs, it never fails that the stock is some random recommendation

[00:01:25] from the client's broker's barber's son-in-law who guarantees the stock is getting ready to take off. Every time this occurs, I always sigh to myself and think, sure it is. Before you go out and try to strike gold, let's find out what a penny stock really is and what risks they have. Pennies on dollars.

[00:01:47] One would think that a penny stock would cost only pennies, right? Well, not quite. Actually, to qualify as a penny stock, the stock price will be less than $5. Here are a few other characteristics of a penny stock. They're not traded on any exchange or the NASDAQ. The company has not met financial standards of listed equity companies. And again, they're priced less than $5. Why are penny stocks risky?

[00:02:17] Many investors are attracted to penny stocks because of the buying power. You can buy lots of shares without a lot of money. And potential payoff. The keyword is potential or better translated as not likely. What makes penny stocks so risky is their lack of liquidity. Penny stocks are not traded on the major exchanges, like the New York Stock Exchange or NASDAQ,

[00:02:43] and are traded on over-the-counter bulletin board, OTCBB, or the pink sheets. The listing requirements of these are far less stringent than the major exchanges, so many of these companies don't have to have as detailed reporting as their publicly traded counterparts. All these factors combined are what make penny stocks that much more risky. Liquidity is an issue.

[00:03:11] Since these stocks are more thinly traded, it can be hard to find a buyer if you hold the stock. And just because the stock may list for a certain price doesn't mean that there's a buyer out there. Think trying to sell a Barry Bonds rookie card for what the pricing guide lists it for. However, chances are you're not going to find a buyer. Beware of penny stock scams. Many of us have been exposed to some sort of scam promoting penny stocks.

[00:03:41] According to a study conducted at Oxford, 15% of all email spam was related to penny stock fraud. According to the study,

[00:04:08] The most common penny stock fraud is the pump and dump. A small group of speculators will accumulate a large number of shares in a penny stock. Once their positions are in place, they'll release positive financial propaganda. News so unexpected and titillating, it can drastically affect people's perception of the stock. The intent is to get small-time investors to start trading irrationally. The news is almost always false.

[00:04:38] But before this is discovered, the price of the stock often skyrockets, and the original speculators exit with large profits. Over the years, I've received countless solicitations at work from cold-calling boiler room types trying to get me to take a look at a hot stock so that I would call my clients about it. It never failed that this next supposed gold mine was some thinly traded penny stock that was going anywhere but up.

[00:05:07] Here's a sample email I just received trying to convince me to buy the next hot stock. FYI, I changed the symbol to protect you from rushing off and buying it. ABCD Energy Corp. Symbol? ABCD. Trading? 32 cents. ABCD Energy Corp. is an oil and gas exploration and development company based in Denver, Colorado, with a focus on Wyoming.

[00:05:34] Using a geology-based methodology, the U.S. Geological Survey estimate, a mean of 2.4 trillion cubic feet of undiscovered natural gas, and a mean of 41 million barrels of undiscovered oil in the Wild River Basin province of Wyoming. ABCD Energy Corp. has acquired 75% working interest in the Diamond Springs Prospect, located within this prolific area.

[00:06:03] The company's shares are publicly traded on the OTCBB under the ticker symbol ABCD. Get in before the word hits the street. Another example of a scam that I and another blogger, Mrs. Micah, both experienced was receiving a fax at work involving penny stocks.

[00:06:23] The fax is made to somebody else's attention, and you're led to believe by the scammers that you've been on the receiving end of some inside information by mistake. They're hoping that you'll go out and buy the stock and tell all your friends to buy it too. If you get a similar fax at work, don't call your stockbroker or think about logging into your online brokerage account to buy it. Head to the shredder and save yourself the trouble and money.

[00:06:54] You just listened to the post titled, What is a Penny Stock? by Jeff Rose of GoodFinancialCents.com. I don't think much about penny stocks because to me, this isn't investing. It's gambling. I put it in the same category as other speculative things like cryptocurrency. It preys on the emotions of greed and fear of missing out. And don't get me wrong, gambling can be fun. But I think we need to put it into perspective.

[00:07:22] We need to ask ourselves, what is our goal in participating? For me, when I invest my money in low-fee total market index funds, my goal is to build long-term wealth. I recognize that the volatility of the stock market will cause my investments to fluctuate in the short term. But over the long term, the stock market always goes up. However, if I walk into a casino, my goal isn't to build wealth. It's to have fun.

[00:07:51] I recognize that more likely than not, I'm probably going to lose money. So I'm not going to risk too much of it. Investing used to really intimidate me because I confused it with gambling. I thought I was going to have to pick stocks, buy and sell, make bets, and pour over financial statements. But now I understand that I don't have to choose stocks. I can simply buy all of them. And by not trying to beat the market,

[00:08:17] I can reliably grow wealth through the power of compound interest over the long term. That should do it for another edition of Optimal Finance Daily. I'll be back tomorrow as usual. So I'll see you there on the Wednesday show, where your optimal life awaits.