Pros and Cons of Investing in Penny Stocks

About Penny Stocks

Stocks that trade at a significantly lower price with low market capitalisation are called as penny stocks. These stocks are less frequently purchased due to the smaller number of buyers and hence are also termed as illiquid. The high illiquidity adds to the speculative nature of the stock, as the risk of reselling the stock increases.

Since penny stocks are speculative, investment in right penny stocks can help an investor make an unparallel profit for a meagre investment. Contrary to this, any investment in penny stocks can make the investor lose money due to low liquidity and exposure to other volatile risk factors like price manipulation. Moreover, in penny stocks trading, there are lesser number of shareholders and restricted disclosure of information.

In the Australian stock exchange, the stocks which are trading for less than $1 are generally classified as Penny Stocks. However, the trading price for penny stocks varies in different securities markets around the world.

Pros of Penny Stocks

• Very low price

The major attraction for the investors to invest in the penny stocks is the low price of the stocks. The prices are as low as counted in pennies and does not require a huge investment which makes it favourable for the investors with a limited budget. An investor can buy a greater number of penny stocks as compared to other stocks within a limited amount of money. This can help investors to have a large interest in a company.

• Higher Return on Investment

Penny stocks demand very less investment as their prices are very low. However, the likelihood of return on the investment made is higher since the companies trading are new, and there is a lot of scope for them to grow. The growth and progress of the company directly impact the stock prices. The penny stocks moving up can help the investors to make good money for very less investment.

• Less number of investors

One of the advantages of investing in penny stocks is that there is a lesser number of investors available for purchasing the stocks, which makes the stocks available for purchase almost anytime. The low-cost investors can make the purchase of the penny stocks at any time and can find the stocks of any company available for purchase. However, sound knowledge about investment and company’s performance along with due diligence, can save the investor from risking his money. In addition to this, a lesser number of investors means that stocks of different companies are available for purchase.

• Short term liquidity

Penny stocks are considered as a short-term financial investment that is a good option for maintaining a diverse portfolio. However, in financial terms, the investments preferred are of long-term nature. Therefore, the investment in penny stocks increases the liquidity of the investor as the stocks can be traded anytime.

Disadvantages

• Illiquidity

Many penny stocks trade on small exchanges where a lesser number of shareholders make a trade. The insufficiency of the number of shareholders affects the liquidity of the penny stocks. A lesser number of available shareholders means less liquidity for the stock. Also, the companies that issue penny stocks are new in the business or start-ups and therefore attract a lesser number of investors. The penny stocks carry a huge illiquidity even though they can be bought for a very low price.

• Risk of Manipulation

Penny stocks are highly prone to the risk of manipulation by the manipulators since there is lesser trade on the exchange. Buy, Lie and Sell High is a common scam encountered in the trading of penny stocks. For manipulation, the manipulator makes a significant investment in the stocks of a company which easily increases the prices of the stocks and the trade for the same also increases. Later, the investor withdraws his investment when the share prices have increased, leaving other small shareholders bear the loss of fall in prices of the stocks.

• Less information sharing

One of the major characteristics of the companies issuing penny stocks is that they share limited information with the investors. By sharing less information, a company’s management is at an advantage of manipulation and insider trading. Access to limited information draws a curtain over the bankruptcy position of the company, which adds to the risk in trading penny stocks. An investor may lose all his investment, however small, due to limited access to information if the company is at the verge of bankruptcy.

In addition to this, the companies listed for penny stock trading are new with small capitalisation and controlled information sharing. The availability of less information limits the research ability of the investor about the company's performance and future. Also, there is a huge risk that the information shared with the investors is not manipulated.

• High Volatility

Penny stocks are generally known for their risky nature and uncertainty of return. Even though the price for the penny stock is very low, the amount of investment in the penny stocks is less due to high volatility. Low liquidity, limited information sharing, and risk of manipulation make it less favourable for the investors to invest in penny stocks with a huge uncertainty of getting a return. The chances of losing all the money in trading penny stocks are always as prominent as the chances of gaining on the investment.

Few Penny Stocks

Following is a glance at two penny stocks that are listed on the ASX:

Painchek Ltd (ASX: PCK)

Painchek is a healthcare company primarily dealing in the smart assessment of pain through AI and facial recognition technology via a phone-based app. The company has regulatory approval in Australia and Europe for its product PainChek^®.

In another announcement dated th September 2019, the company notified the appointment of Mr. Pete Shergill as the Head of Business Development for PainChek UK Ltd. With more than 20 years of experience in the UK healthcare and software business, Pete Shergill commenced his job with the company from 30th September 2019.

In an announcement dated 6th August 2019, the company highlighted the regulatory approval for the PainChek^® from Singapore's Health Sciences Authority for the usage of its products in Singapore.

At the time of writing i.e., 03rd October 2019 (AEST 1:02 PM), PCK's stock was trading at a price of $0.315, with a market cap of $304.62 million. In the last six months, the company's stock has increased by 842.86%.

DigitalX Ltd (ASX:DCC)

DigitalX Ltd is a Blockchain company with presence in 3 cities - Perth, Sydney and New York. The principal activities of the company include Advisory; Blockchain consulting; Funds under management; and Media (via its joint venture).

FY19 Major highlights

• The company’ contributed equity increased by USD 3,230,731 (from USD 30,431,588 in FY18 to USD 33,662,319 in FY19), as a result of shares issued for strategic placements, conversion of options and conversion of convertible notes.
• Increase in the Group's cash and digital asset position by USD 2,000,493 (from USD 10,272,569 in FY18 to USD 12,276,062 in FY19), strengthening the Group's financial position ahead of the 2020 financial year.

At the time of writing i.e. 03rd October 2019 (AEST 1:04 PM), DCC's stock was trading at a price of $0.029, with a market cap of $17.29 million. In the last six months, the company's stock has decreased by 49.12%.

Bottom Line

It is difficult to trace and predict the pattern of the penny stocks due to high volatility and unrelatedness with the company's financial performance. However, the investment in a correct penny stock, even though by chance, can deliver huge profits for the investor. Due to controllable factors by the company, there might be chances that the prices of the penny stocks reflected may not be the same as its exact value. A close eye on the market and analysis of the company information can help to minimise the risk of uncertainties involved with the trading of penny stocks.

Disclaimer

This website is a service of Kalkine Media Pty. Ltd. A.C.N. 629 651 672. The website has been prepared for informational purposes only and is not intended to be used as a complete source of information on any particular company. Kalkine Media does not in any way endorse or recommend individuals, products or services that may be discussed on this site. Our publications are NOT a solicitation or recommendation to buy, sell or hold. We are neither licensed nor qualified to provide investment advice.