Friends and family often ask me where they should put their money now.
I always answer, “Penny pot stocks…”
And then emphasize that I’m kidding.
But people do love themselves some penny stocks. Investors dream of buying a stock in the low single digits and watching it explode to double digits, making many times their money.
However, there are a lot of misconceptions about penny stocks…
So once and for all, I’m going to let you in on what is true and false about them.
Myth No. 1: Penny stocks have greater potential to double or triple than larger stocks do.
Investors believe it’s much easier for a $2 stock to become a $4 stock than it is for a stock trading at $100 to rise to $200.
Tell that to owners of Tesla (Nasdaq: TSLA)…
The stock traded at $211 in September 2019. It climbed to more than $1,200 just over two years later.
A stock’s price will have no effect on whether it can rise 10%, 20% or 100%. What matters is how much supply and demand there is for the stock.
If a small company makes a big announcement but no one is following it, it might be hard to drum up interest in the stock.
On the other hand, when an unknown company like Houston American Energy (NYSE: HUSA) suddenly finds itself in the spotlight, the stock can rise from $1 to more than $16 in one month like Houston American Energy did in 2021.
Myth No. 2: All penny stocks are tiny companies with little revenue or profits.
There are quite a few energy companies whose stocks trade for under $5, such as TransGlobe Energy (Nasdaq: TGA), which is profitable and growing. There are also companies like Destination XL Group (Nasdaq: DXLG), which trades below $5 and generated more than $500 million in revenue last year.
Sirius XM Holdings (Nasdaq: SIRI) has a $24 billion market cap and generated more than $8.5 billion in revenue last year. It trades for around $6.
Myth No. 3: Investing in penny stocks gets you in before Wall Street’s big players.
This is partially true.
Many mutual funds and other institutional investors have their own rules against buying stocks that trade below $10 or $5.
But many others do not have those restrictions. There are plenty of hedge funds and other institutional players that own penny stocks.
Myth No. 4: Penny stocks don’t pay dividends.
Most penny stocks don’t pay dividends because many are still young companies in their early growth phase.
But some do…
Sirius XM pays a dividend. So does Manhattan Bridge Capital (Nasdaq: LOAN), which trades for around $5 and pays a 9% yield.
Myth No. 5: All penny stocks are risky.
A lot of penny stocks are garbage companies. Many others are priced low for a reason.
But there are plenty of quality companies – businesses that are just beginning to gain some traction, undiscovered by Wall Street – that make for great investments or short-term trades.
If you trade penny stocks, make sure you understand the risks, the potential profit, why you’re making the trade you are and what strategies you have to limit your risk, such as trailing stops.
Penny stocks can be lucrative as long as you know what’s true about them and what’s myth.