Search Google for penny stock and you will be deluged with sites promoting active, short term and day trading of penny stocks. This attracts people due to the greed factor (the promise of huge % returns in short time) , the “I don’t have much money” factor, and lastly the knowledge (or lack of) factor. All these sites prey on these three aspects to get people to sign up to learn about trading penny stocks or at least try to. Most of the time, their version of day trading is holding for a few days, rather than only go in and out the same exact day.
Now not all of these sites are bad, and not all penny stocks are scams. There are a few sites and newsletters that are in it for the longer haul, really trying to find the diamond in the rough. The only issue that is never talked about is the true rarity of that happening. I do not have exact stats, but I would guess for every 1000 penny stocks, maybe less than 5 ever build up to a real company and get listed on a regular exchange. What is a regular exchange? Nasdaq NMS, Nasdaq small cap, or NYSE. The rest go to 0. It may take some time, but it happens – maybe a few get taken over or merge but rarely is it a huge boon to shareholders. Its usually a take under at some point. It is these types of stocks that people who want to learn about day trading are drawn to often times, and especially people who think they can take $500 bucks and turn it into 1 million. If that were the case, Warren Buffet could take 100k and turn it into 100 million using this method – I highly doubt he could even turn the 100k into 100k (0% return) after a year investing in this stuff.
Think about one thing for a second – the primary way companies go public is: 1 – Have a great idea for a business, 2 – incorporate, find partners, build business some, 3 – if its going well, raise capital with private placement OR VC (venture capital) depending on the industry, 4 – expand further, grow margins and get profitable or very close to it with a well defined plan, 5 – plan to go public OR sell/merge company with a bigger competitor.
Now contrast this to the way most penny stocks are capitalized: 1. Think of a business idea (could happen AFTER step 2), 2 – buy a shell company (listed on pink sheets, but no business or revenues, you buy the name and the other legal stuff from someone), 3 – formulate a business plan, talk with brokers about getting the word out about your company, 4 – issue press releases about your business (usually whatever is hot at the time is a magnet “to do” stuff), issue shares to pay consultants to pump stock, issue shares to pay yourself a salary, issue shares for rent, issue shares for equipment, issue shares to maybe hire someone (all of which get dumped into the pump scheme designed to keep volume in the stock), …. and on and on. You should notice a difference between the 2 by now. One is a bona fide business from the get go, the other is basically a concept reversed into a public shell, with everything else as an afterthought. That does not mean ALL are like that, but a large percent of them are.
If that did not deter you, lets look at the capitalization issue. A lot of penny names have 10s of BILLIONS of shares outstanding, I personally have seen as many as 800 billion outstanding. So lets take a lower number, but prob average of 5 billion shares outstanding for company XXYY. Also, lets assume the stock is trading at 0.002 per share (penny stocks can trade as low as 0.0001 that is the lowest increment before 0). But we are giving XXYY the benefit of the doubt. Lets see what the market cap is on XXYY. 5bil x .002 = 10 million bucks market cap. This is common. The company has 0 revenues (or very little at all), and is basically like saying your home based business with a big idea is worth 10mil – prob not even worth 10,000.00 with no sales.
Think about it. If you actually had 10mil, would you give it to a company that has no products, has a unique concept (maybe) and is working on a business plan? Hell no, not a chance. Even if a company was profitable, the general rule is a low multiple x earnings for last 12 months OR revenues, depending on the sector. This company has no earnings and no revenues or even a product. Its pure hype. So if the business makes 2 mil a year (profit, not revenues) you MIGHT pay 10mil for that biz. With 5 billion shares outstanding, even if they earn 2 mil a year that equates to .0004 cents per share earnings. Lets say we give them a PE of 100, that means it could trade at .04. If you take .04 x 5 bil that means the market cap is 200 million dollars. Is that company worth that much? Highly doubt its worth even 1/10th that.
The hype is always so compelling – turn 2k into 1 million bucks etc IF it works and IF it goes up bla bla bla. The real driver of any company is only 2 factors: earnings per share we just talked about OR what another company would pay to take that business over. If you think about it, the hype always says turn $1000 into $10mil etc. If many of these types even went to 1.00 per share, with that many shares outstanding, they would exceed the market cap of even GE, XOM or many other huge multinational corporations. I really don’t see how that is even remotely possible.
Lets take another look at earnings per share, and see what it would take for company XXYY to earn .10 per share, then we will be super generous and let it trade at a 100 PE ratio again so its a 10 dollar stock. That would be considered a massive home run in anyone’s book. To earn 0.10 per share, the company NET PROFIT would have to be $50,000,000 – now lets be generous again, hugely, and say XXYY is in the software business and gets the same margins as MSFT (Microsoft) of 80%. This would mean their revenues are about $70,000,00.00 with no expenses at all. Most of the time, the entire market for the good or service these companies are in, assuming 100% market share and no competition is not even that big. How many people go from a concept to 70mil in revenues? Very, very few. Most cannot even get product sales much before they implode. These companies often cite the POTENTIAL market in the billions of dollars, but they falsely assume they can grab a certain percent of the market when often times even if they were the only competitor they cannot handle it because they lack the capital to do much of anything. Ever heard the term “it takes money to make money?” It is true here as well.
If this still does not dissuade you, the fact that the company is not even regulated (barely is) nor required to publish financials that are audited on the pink sheets, and the double combination of the pump schemes to hype stocks so the company can sell shares to earn money (them and their buddies) makes it a huge game of musical chairs. You can always buy penny stocks (market order, please!) but you will have a hard time selling them. The market makers do not want this junk on the books either, unless they have orders to buy it and they can make money reselling the stock at a higher price to another sucker. Sure these stocks move sometimes, but do you actually believe you can outwit the market repeatedly and evade the eventual collapse?
Usually people think they can outsmart the pump and get in early and out before its done, meaning they realize its a scam but the gambling mentality just keeps them trying it. This might work 1 or 2 times, but keep it up you will eventually lose every penny you put into your account as you get trapped in the stocks for 20,30,50 or even 100% losses when it does not work. Don’t fall into this trap, if you want to gamble, trade forex where you have a legitimate chance to actually make some money and do not need a large account to start. Or just go to Vegas and bet on red.
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