Visually cheap stocks are not necessarily cheap
Penny stock trading volume nears 2000 level
A total loss must always be taken into account
Penny stocks are shares that are traded at a price of less than one euro or a few cents. This magical price threshold of less than one euro is five US dollars in the USA, in contrast to Europe. Accordingly, all stocks with a market value of less than five US dollars are referred to as penny stocks in the USA. This somewhat different definition goes back to the regulations of the major US stock exchanges, which prescribe a minimum price of five US dollars for a listing.
The psychological effect of penny stocks
The main reason for the great popularity of stocks that cost less than one euro or five US dollars can be explained primarily with a psychological effect. The extremely favorable price suggests namely, especially to inexperienced investors, that the respective share is particularly inexpensive and thus offers high price increases. In order to achieve a return of 200 percent, a penny stock “only” has to rise from 20 cents to 60 cents, for example, while a blue chip has to climb from 50 to 150 euros.
Many investors consider the probability that a share certificate will rise from 20 to 60 cents to be significantly higher than the possibility that a share will rise from 50 to 150 euros. However, the percentage gain is identical in both cases.
However, this psychological effect is also readily exploited by larger corporations, which use a share split to make their own shares appear cheaper. Because for many private investors, a share certificate with a price of 25 euros is much more attractive than a share that costs 400 euros, for example. However, many investors seem to ignore the fact that the price of a share has nothing to do with the value of a company.
Not every penny stock is a “pig in a poke”
A share that is listed at a level of around one euro does not necessarily have to be a speculative penny stock. In countries such as Australia, Hong Kong and Great Britain, for example, it is more the rule than the exception that stocks sometimes have very low prices. For example, shares in the British telecommunications group Vodafone are “only” listed at around EUR 1.50, even though the company, with a market capitalization of over EUR 40 billion, is one of the largest mobile phone companies in the world.
A very similar constellation can be seen at the Australian aluminum producer Alumina. Despite a solid valuation and a market capitalization of around 3 billion euros, the group’s shares are only listed at around 1.10 euros per share.
Accordingly, investors who want to distinguish a blue chip from a penny stock should not only consider the price of the respective share, but above all the total market capitalization. Because classic penny stock companies are often worth only a few million and not billions.
Gambler papers keep Wall Street busy
New trading platforms and apps, which are gaining in popularity in the USA in particular, are currently ensuring that more and more private investors, primarily young ones, are trying their luck on the stock market. So it is that just six companies, each listed at around one US dollar, accounted for almost a fifth of the entire US trading volume.
These penny stocks include other companies such as Zomedica and Sundial Growers. While Zomedica produces various medicines for animals, Sundial Growers is a Canadian pharmaceutical company that produces various types of cannabis.
With a price of around 1.90 US dollars, the Zomedica share is currently being quoted well over 500 percent above the level of last December. In this context, many experts point out that penny stocks such as Zomedica and Co. are very popular with young Reddit users in particular. The veterinary drug company’s stock multiplied after the company was mentioned more often on Reddit.
The bigger fool theory
Speculators who buy and push individual penny stocks with the help of social media such as Reddit usually follow the so-called greater fool theory. This theory describes an investment strategy that assumes that a stock can be bought well above its fair value because there is bound to be another investor who will buy the stock at an even higher price. That buyer is then labeled the greater fool because he’s paying an even higher price for the grossly overvalued stock.
“The lure is there because stock prices are so low. [] And with high risk comes the potential for high reward. Individual investors end up seeing a lot of this potential. You see someone who has made a 10,000 percent return on a penny stock or even just doubled their money and that’s because it’s easy for a stock to go from 5 cents to 10 cents,” said Stephan Shipe, stock market analyst at Scholar Financial Advising LLC, to Bloomberg on the rally in some penny stocks.
The small market capitalization can become a problem
“Probably one of the biggest risks is with those [Spekulanten] have to do with the size of the companies in general,” Shipe continues. Since the market capitalization of penny stock companies is usually very manageable, they offer investors less protection than standard stocks. This means that it can quickly become difficult to sell come because smaller companies often only have a low trading volume.
In social media, chat rooms and forums, individual users can use positive news and publications to ensure that trading volume and interest in a specific stock increases, but such influence borders on price manipulation.
Beware of pump and dump!
Therefore, penny stocks in particular are very susceptible to so-called pump-and-dump systems. The classic pump-and-dump is a scam designed primarily to rip off smaller retail investors.
In addition, various reports on smaller companies are published and disseminated, often by dubious stock market letters or shady stock market gurus, which are intended to encourage the purchase of the respective penny stocks with fictitious price targets. However, behind the purchase recommendations, mentions and press releases, which are often very elaborate, there are fraudulent organizations or individuals who bought the respective shares before the first major publication or recommendation and are therefore only waiting for it. to get rid of them with hefty price increases. In Germany, such a method is also known as a scalping strategy.
Penny stock – more betting slip than share slip
In any case, investors who are determined to invest their money in penny stocks should keep in mind the enormous risks involved. With penny stocks in particular, it is more the rule than the exception that the investment ends in a total loss in the long term.
“Just make sure you can afford to lose and have rules about how you bet,” said Scott Cole of Cole Financial Planning in a Bloomberg interview. In principle, of course, there is nothing to be said against manageable commitments in the area of penny stocks, but in this context one should rather speak of speculative bets than of sensible investments.
Pierre Bonnet / Editor finanzen.net
This text is for informational purposes only and does not constitute an investment recommendation. finanzen.net GmbH excludes any claims for recourse.
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