A few years ago, a good friend told me that he first invested in penny stocks because of the word “penny.” He naively assumed they were an inexpensive and relatively risk-free way of getting into the stock market. He was half-right: the unit price of a penny stock is generally low (in the past, many actually traded for pennies, hence the name). Whether or not they’re inexpensive, however, depends on how much you’re willing to spend. But one thing they’re not is risk free. To be fair to my friend, his mistake was a common one and, like him, many people have the wrong idea about penny stocks.
So, what exactly are penny stocks? There isn’t a single, agreed definition of the term – it varies depending on whom you ask. Nevertheless, penny stocks usually have all or most of the following four characteristics:
- Low stock price, usually below $5, often much less
- Relatively small market capitalization, usually below $300 million, often much less
- Limited liquidity due to low trading volume
- Not traded on major stock exchanges
Investing in penny stocks is significantly riskier than investing in stocks traded on the major exchanges for three main reasons. First, unlike stock traded on the tightly regulated major exchanges, penny stocks are traded on the OTCBB (Over-The-Counter Bulletin Board) and the “pink sheets.” The OTCBB is an electronic trading service provided by the National Association of Securities Dealers. It has limited listing conditions, though there are requirements for companies to file some financial information with the SEC (Securities and Exchange Commission). The “Pink Sheets” is a list of OTC (Over-The-Counter) stocks published daily by the National Quotation Bureau. The stock ticker symbol of such companies has the suffix “.PK.”
Second, detailed reliable information about the underlying companies and their principals is usually difficult or impossible to come by. This means that prospective investors struggle to make informed decisions on the stocks’ potential.
Third, frauds are widespread in this largely unregulated environment. A common and relatively easily perpetrated fraud is the biased promotion of the stock by unscrupulous individuals. These often-plausible tricksters are paid to disseminate misleading or even false information about a penny stock company with the aim of convincing gullible people to buy the stock. Since trading volume for most penny stocks and the total number of issued shares are both low, a relatively small number of people unexpectedly purchasing the stock can dramatically affect the price. When the price peaks, the scammers make a large profit by suddenly selling their shares, and leave the gullible new shareholders holding a whole lot of virtually useless paper.
Yet, with penny stocks, as with every kind of investment, there’s a broad range of risk profiles. Not every penny stock is connected to fraudulent activity. Many are the stock of legitimate companies and some return good profits to their stockholders. The problem is that filtering the good ones from the bad is almost impossible because of lack of dependable independent information. That lack of information coupled with an inherent illiquidity makes the best of them risky investments.
After all that, I’m now going to be the true contrarian and go on record for a specific penny stock! Why? Because, for careful people who do their homework, penny stocks can yield significant returns. And being a contrarian, I naturally think outside the box and tend to follow my gut feeling. The stock in question is Bontan Corporation (OTCBB BNTNF). But first, I must state my personal interest: I’m a shareholder, as are other family members. I don’t represent the company, receive compensation from it, or expect to receive any compensation in the future (apart from benefiting if the stock performs positively). I’m involved primarily because I believe that, unlike many penny stock companies, Bontan has exciting short- and medium-term plans. Those plans are both exciting and credible, and are the reason I think that the company’s prospects are very encouraging.
Briefly, the plans revolve around a complex deal Bontan is currently working on with Portage Pharma Ltd. – a deal it expects to conclude by April 15. Portage Pharma’s management team is impressive. It boasts some big names in the biotech business – people with remarkable track records who understand the biotech industry intimately and the potential of the current deal with Bontan. Nevertheless, like all penny stocks, indeed all investments, it’s not without risk. (See my recent blog article about shrewd investing “Investing 101: Apple’s Lessons for Investors.”) For me, however, Bontan is not a run-of-the-mill penny stock company. That’s why I’m an investor and why I’m endorsing it. Of course, it’s a risk, but it’s one I’m willing to take.
For those interested in learning more, below is the March 26 2013 Press Release about the proposed deal and the two companies involved.