Reasons to Invest in Penny Stocks

Penny stocks are very low-priced stocks, usually belonging to small companies. Although some investors view them as too risky and speculative to be worthy of serious consideration, others think there are many valid reasons to invest in penny stocks. Although the risk of loss is high, the potential payoffs can be very high too. As long as penny stocks are approached carefully and on a case-by-case basis rather than simply as a sort of gambling, advocates of penny stocks say they can be valid and highly lucrative investments.

Officially, according to the U.S. Securities and Exchange Commission (SEC), a penny stock is a stock that is priced at less than $5 per share. Usually these stocks are not listed on the major exchanges, and instead must be bought and sold “over the counter.” Penny stocks may also be called “micro-cap stocks.” Investopedia says that in the U.S., penny stock companies typically have a market capitalization in the tens to low hundreds of millions of dollars. It may be more difficult to find sellers (or buyers) and financial information for penny stocks than for listed companies.

That can be enough to scare off some investors, but Forbes writer Jordan S. Terry, founder of Stone Street Advisors, says there are still reasons to invest in penny stocks. The most important reason, and the main reason penny stocks remain attractive to their advocates, is that a small company can collapse very quickly, it can also explode into a high-profit giant very quickly, too. Volatility works both ways. The downside to a penny stock is that investors could lose everything they put in, but the upside is their stocks could increase in value by an order of magnitude just as quickly. Sorting out which is which requires a great deal of research combined with some amount of luck. Otherwise, warns one investment blogger, “penny stocks are roughly equivalent to going to the horse track and throwing down your ‘investment money’ on the most creative name.”

Still, for those who can stomach the risk and are willing to do their homework, advocates say that penny stocks can be a valid investment strategy. In 2012, Scott Rubin published a column on MSN Money listing several of the big winners in the penny stocks game. These are companies like Pier 1 Imports, which sank to a price of just 11 cents per acre in 2009. The company had been in decline for years, but its executives decided to hang on rather than declare bankruptcy. The shares recovered spectacularly, rising to over $20 in 2012. When penny stocks take off, that sort of explosive rise is far from rare. Another success story on Rubin’s list is Concur Technologies, which sells travel and expense management software to more than half of Fortune 500 companies. Concur’s shares crashed down to 31 cents a share during the collapse of the dotcom bubble in 2001. Today, they trade at $66 – a gain, says Rubin, of about 21,190 percent.

The second reason to invest in penny stocks, says Michael Sincere of Market Watch, is that they allow investors who don’t have a lot of money on hand to invest in a wide range of companies. Buying shares in large, popular companies is expensive. One share in a large, popular, successful company could cost hundreds of dollars – as of June 2013, stock in tech giant Apple (AAPL) was trading at around $400. That amount of money can buy penny stock in hundreds of different companies.

Of course, there’s a reason why Apple stock is expensive and penny stocks are cheap – other investors are confident about large, proven companies, and nervous about small, unproven ones. However, for those willing to do a great deal of research and stomach an equally significant degree of risk, the reasons to invest in penny stocks – a cheap way to diversify, and the promise of a potentially huge payoff – may outweigh the potential drawbacks.