January 8, 2008
Ford Stock Quote
This warning goes out to newbie investors, and more times than not, it falls on deaf ears. But I’ll repeat it one more time just for posterity’s sake: if you’re new to investing, be very careful of making investments in penny stocks. You will undoubtedly be very attracted by the potential returns due to the deflated share prices, but keep in mind that things are usually not what they seem to be, and sometimes penny stocks really are “too good to be true.”.
Why do pennies pose such a risk? In a word: reporting. Or more accurately, lack of reporting. Since Over the Counter (OTC) stocks are not listed on any exchange, they don’t have to follow the stringent reporting criteria which we’ve all become accustomed to for major exchange traded stocks. What this means is that these companies generally offer very little financial guidance, and tend to rely much more on hype than exchange traded stocks.
Penny stocks usually have very small floats (the amount of shares actively traded) and for this reason, coupled with thin capitalization, the stocks can be manipulated quite easily by several buyers or sellers, and some news or rumors. Many penny stock companies use spam email to promote their products. They send out to large groups of internet users who end up becoming interested in the stocks. As the emailed people start buying, the price goes up, and the investment starts to look like a great deal. At this point, the pump and dumpers will start selling all the shares they can, and the investment will come back down to Earth. The pump and dumpers make the money, and the investors who come in later are left holding the bag.
These pump and dump schemes are extremely common, and penny stocks are almost always what are used for the promotion. Particularly vulnerable to this ruse are small and new investors who have tiny amounts of capital. Most of these types of investors want to accumulate a large amount of shares with the hopes of turning a meager $200-$500 investment into a retirement nest egg. Most end up losing their capital.
These warnings might seem obvious, but it’s amazing how often people lose their head when dealing stocks. Most people feel that the number of shares is their best chance for making profits. They feel if they can but 100,000 stocks for 0.001 that somehow they’ll get rich if only the stock hits 1 cent! This is true, of course, but almost never happens. Most stocks that sell for fractional pennies are more likely to stay in that neigborhood rather than to rocket to even $10.
Remember that the only metric you need concern yourself with as it relates to investing is total returns. The higher your percentage return, the more money you have. You will never end up concerning yourself with share price if you are a studious investor. It’s meaningless in the final analysis. For savvy investors who do a ton of research, finding a bargain in the penny stock heap is possible. Once you’ve done a few trades of “normal stocks” give it a try, but lay off the pennies until you have a very good understanding of what makes share price move.
About the Author
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Its Stocks, Not Markets, that Bring Investment Success by Gabriel Nijmeh
If you are fairly new to investing and looking for some guidance or if you are seasoned investor, let me introduce you to NAIC.
National Association of Investors Corporation (NAIC) is a non- profit, tax exempt organization whose membership consists of investment clubs and individual investors. Founded in 1951, the mission of NAIC is to provide investment education, information and support. They prescribe to four basic, yet timeless investment principles:
1. Invest regularly, regardless of the present outlook for the economy or stock market.
2. Reinvest all earnings, letting the power of compounding work for you.
3. Discover growing companies so that your wealth can grow as their sales and earnings grow over the years. 4. Diversify your holdings, and don’t put all your eggs in one basket, regardless of how carefully you watch that basket.
The late George A. Nicholson, Jr. CFA - father of the modern-day investment club movement, gave these principles to a good friend in 1939 and told him that if he followed them he would make the money he needed to start his own business.
“I never thought these principles would be so aggressive,” Nicholson once told Better Investing editors. “They were meant to be defensive, to protect investors from losing money. They turned out to be quite offensive, too.” He enjoyed comparing this approach to investing with his college football experiences. “The best offense is a strong defense.”
I can attest from own experience of such a disciplined investment program. For the most part, I have invested exclusively in mutual funds because I never had the time or experience to properly research and analyze individual stocks. One day as I was reading through the business section of my local newspaper, I came across an organization called the Canadian Shareowner Association (CSA) which piqued my interest. I started researching it a little more and as a result of my research stumbled on NAIC’s web-site, which then lead me to learn about Warren Buffet and his style of disciplined investing. The Canadian Shareowner Association follows a lot of the investment principles of the American based NAIC.
Membership to CSA is inexpensive and the educational materials are very informative and drive home the above noted investment principles. For only $79 a year, I decided to join the CSA which includes a bimonthly magazine with two company stock studies, market outlook, financial planning and more. In addition, I have access to the low cost investing program where I have set-up my investment plan. The great thing about such a program is that you can buy shares in any dollar amount from such companies as Johnson and Johnson, Microsoft, Pfizer, Wal-Mart. Your money is pooled with other investors and trades are executed during specified trading windows. For example, if you invested $50 in a stock that is trading at $30, you will own 1.67 shares. Another great feature is that dividends are automatically reinvested allowing for compounded growth.
Whether you join an investment club or are a self-directed investor, you work at your own pace. Learning how to analyze companies using the stock selection guide which is a tool that was created over fifty years ago and is organized in five sections. The section guidelines will help you determine if the company would be a good investment by:
1. Evaluating historical sales and profit growth and estimate future growth
2. Analyzing historical management performance 3. Analyzing historical profit and price data 4. Evaluating risk and reward and; 5. Determining the potential return on an investment.
The software is easy to use and you can download company profiles with historical information thus saving you data entry effort. As company financials are released quarterly and yearly, you just enter the information and keep an eye on performance.
For more information, you can check our http://www.better-investing.com or http://www.shareowner.com to find out more information.
Finally, if you want to be a successful investor keep in mind the following:
1) A focus on the long term. 2) A discipline to apply in building and managing a portfolio. 3) Patience to persevere.
Bear or bull markets, a sound, disciplined investment strategy will bring you investment success over the long-term.
Gabriel is the editor and webmaster of The Money Advisor - http://www.the-money-advisor.com. He believes that everyone is capable of controlling their financial destiny with the right combination of rich thinking and smart action. The Money Advisor, a knowledge network of people, articles, tips, e-books and ideas about making money, saving money and building wealth!
