What are penny stocks?
Some of the typical characteristics of a penny stock include:
- Small company
- Market cap below $15 million
- Newer company recently listed
- Share price below $5
- Limited financial track record
- Doesn’t pay dividends
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Investing in penny stocks
What exactly are penny stocks and how can you invest in them?
The term penny stocks is commonly used in the US, UK or Europe, but you may have heard the phrase in New Zealand too. So what are penny stocks?
Penny stocks is a loose name for cheap, low-priced shares of small, often newly listed companies. There are a few different ways to define penny stocks. Some definitions say it’s listed companies with a market cap of less than $15 million, which is why penny stocks are also commonly referred to as small-cap stocks. Another definition is stocks with a share price of less than $5. However this is a rather vague definition as some blue chip stocks have share prices below $5 too.
Investors are often attracted to penny stocks for their cheap prices and potential growth opportunities, though there are risks involved with penny stocks, too.
Pros and cons of penny stocks
Here are some of the benefits and risks of investing in small-cap penny stocks:
Pros
- Low prices. Because they’re low priced, investors can hold a diversified portfolio of penny stock companies without needing to spend as much as they typically would.
- Growth opportunity. Small-cap, newly listed companies can often present great growth opportunities if you pick the right ones. However it could be a bumpy ride to the top.
- Thrilling. Penny stocks often see their share prices change significantly in little time, which can be exciting and thrilling for investors with a high risk tolerance.
- Day trading. Because of their large price swings, penny stocks are often used by active day traders.
Cons
- High risk. Penny stocks are very high-risk investments compared to other listed companies and ETFs with a longer financial track record. Not all companies that list on an exchange do well and a lot of penny stocks never become anything more than a penny stock.
- Very volatile. Penny stocks often experience extreme share price highs and lows within a matter of days (or even within the same day).
- No income. Penny stocks rarely pay any dividends, as all revenue is usually reinvested back into the company to help it grow.
Penny stocks versus blue chip stocks
On the opposite side of the scale to penny stocks are blue chip stocks. In comparison to penny stocks, blue chip stocks are large listed companies that have been around for a long time and have a long, stable financial track record. Some of New Zealand’s biggest and most well-known companies are considered blue chip stocks, such as Fonterra, Auckland Airport, Spark and Fletcher Building.
While penny stocks in most cases pay no dividends, blue chips stocks almost always do.
Should you invest in penny stocks?
You could consider investing in penny stocks if:
- You have a high risk tolerance
- You’re an experienced investor
- You’re willing to cut your losses if the share price falls significantly
- You have a long investment time frame and are willing to ride out the volatility
- You’re happy to take a bit of a “gamble”
Tips for investors considering buying penny stocks
If you’re keen to invest in penny stocks, here are some tips to help you get started:
Do your research
This is important for all investments, but particularly higher-risk investments like penny stocks. Blue chip stocks are, by their nature, lower-risk options as they’ve got a long history of strong financial performance.
Plan a strategy and stick to it
Before you start buying, decide which penny stocks you’re going to invest in and how much you’re going to invest in each one. It’s also important to decide what price you’d sell at if the shares were to fall and stick to it to avoid the “I’ll just hold a little longer and see if the price jumps back up” mentality. The same applies for gains.
Don’t make emotional decisions
It can be easy to get emotionally attached to a penny stock, as they’re often the underdogs in your portfolio. So when their share price falls and falls some more, you can find yourself making excuses as to why you should keep holding. This is why it’s important to make a strategy, so you leave the emotions out of it.
Don’t get sucked in by the “cheap” prices
Penny stocks may appear to be cheap in comparison to other shares, but don’t base your investment decision purely on this. One factor that influences a company’s share price is the demand for its shares. The less demand from investors, the lower the share price. So some penny stocks may appear to be cheap, but you need to ask yourself why this is.
How to buy penny stocks in New Zealand
- Choose a share trading platform. If you’re a beginner, our table below can help you choose.
- Open your account. You’ll need your ID, bank details and IRD number.
- Confirm your payment details. You’ll need to fund your account with a bank transfer, debit card or credit card.
- Find the shares you want to buy. Search the platform and buy your shares. It’s that simple.
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