Low-Income Earners: Why Penny Stocks are not meant for you

Proshare

 

Wednesday, July 23, 2014 08:30 PM / Research

 

As a low income earner, you have limited fund to save and invest.

 

While considering investments in the capital market as one of the passive ways to grow your fund, you are advised not to personally increase your risk exposure by investing in penny stocks.

 

Why?

 

Simple fact, Penny stocks are not amongst the class of assets you can consider for safe-investing, taking your income profile into consideration.

 

Many investors (experienced or inexperienced) have fallen into the trap of the common fallacy pertaining to penny stocks that many of today's stocks were once penny stocks. Also, many investors may be attracted to penny stocks due to the notion that there is more room for appreciation and more opportunity to own more stock volume.

 

That is, if a stock is trading at N0.50kobo and rises by N0.20kobo, you will have made a 40% return. This, together with the fact that a N10,000 investment can buy 20,000 shares, convinces most investors that penny stocks are a rapid way to increase profits. Where is the data to support this assertion?

 

Unfortunately and truly sad, is that people tend to see only the upside of penny stocks; while conveniently forgetting about the downside.

 

A N1.00 stock can easily go down by N0.50kobo and lose half its value. More often, these stocks do not succeed (as a proportion of value/weight); and there is the ever present probability (high) that you will lose your entire investment.

 

The ProshareLite team is strongly of the opinion that penny stocks are not completely a bad business, but they are a very high-risk investment for the low income earner. If at all you can't resist the attractiveness of penny stocks, make sure you do extensive research and understand what you are getting into. TheANALYST can help here.

 

Penny stocks are stocks with a share price under a certain amount, usually under N5.00kobo per share, though definitions/classifications may vary with different price points according to exchanges around the globe. Be that as it may, here are some basic facts or reasons why penny stocks are not suitable for low-income earners, viz:

 

·         The problem of illiquidity is very common with these classes of assets. It is usually hard to get a buyer on time when it’s time to sell or take profit. At times this seems to have provided opportunities for some manipulative trading like hype/push it up, to make it attractive and sell it off for novice investors.

 

·         The possibility of self-delisting or regulatory delisting is very common as well as many of the companies considered to be penny stocks are either a moribund company or approaching bankruptcy. These companies are usually alive with poor track records or none at all, which make them breaching post-listing rules as we had seen recently on NSE bourse.

 

·         Inadequacy or lack of information seems to be their trademark. Information is very crucial to make informed decision towards investment in capital market. Information is much more difficult to find on penny stocks as majority of these firms have no website or investor relations portal, this makes majority of information about these firms to be inadequate and unreliable due to lack of credible sources.

 

·         The worse is that penny stocks are often subject to extreme price volatility. Some people see this as an advantage, where the price of these stocks can swing 10%, 20%, 50%, within a short term trade. If you're on the winning side of that, you may enjoy it, but if you're on the losing side, the story may be hard to tell.

 

Conclusively, to find any good stock, you have to do your research or consult an expert. To find an undervalued stock, you have to understand the business. Why is the stock price so low? Why is the company struggling? What are the chances it will succeed? You'll always discover that the company behind a penny stock is a risky, struggling business. These investments are more like gambles.

 

We strongly advise that you should always start with the basics- researching the intrinsic value. Can the company earn more money next year than this year? Does the company have a logical and consistent plan to make money, and is it believable? Most times the answer is "No".

 

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