What are penny stocks?

What are penny stocks?

Beginner

1st September, 10:14
Updated: 29th October, 16:59

Thinking about taking a chance on a low-priced stock that could be on the verge of a strong price move?

You can always look into penny stocks. In this lesson, we’ll explain what penny stocks are, go through their typical characteristics, and let you know how to invest in them. We’ve also prepared a list of penny stocks that could make for attractive buys.

What are penny stocks?

Penny stocks are stocks of companies that trade for less than $1 per share. They are sometimes referred to as micro-cap stocks, nano-cap stocks, or OTC stocks. Penny stocks are lower-quality options than other stocks, typically sporting spotty earnings per share and minimal (or negative) revenue growth. 

Why do investors look for penny stocks?

Despite penny stocks’ relative lack of quality compared to other stocks (especially blue-chip stocks), some investors still like to experiment with penny stocks anyway. They do so due to the allure of buying a few thousand shares and realising big gains if the stock price rises just a few cents.

What are the defining characteristics of penny stocks?

1) They trade at pennies per share

This is the only hard and fast rule of penny stocks. While many different fundamental and technical parameters may apply, penny stocks by definition are those that trade at a price of less than $1 per share.

2) They often have spotty fundamentals

Stocks typically rise based largely on the strength of their earnings growth, or at the very least their potential earnings growth. Penny stocks usually trade at that low level in large part because they lack that kind of earnings power.

3) They lack institutional support

Big-money institutional investors such as mutual funds and hedge funds favour highly-liquid stocks that trade in hefty daily volume. Penny stocks lack that kind of volume and liquidity, so institutional investors tend to stay away.

4) They have unfavourable bid-ask spreads

When a stock trades at pennies per share, every cent matters. The problem is that penny stocks’ lack of liquidity also contributes to large spreads between bid and ask prices, which can make it difficult to get in at the purchase price that you want.

Here are some examples 

(Warning: Penny stocks are far more volatile and far more speculative than other stock types. We are highlighting these four stocks, but also advising extreme caution, and reminding you that other stock types typically make for safer investments.)

1) Sequential Brands Group (SQBG)

The parent company of lifestyle retail brands such as Jessica Simpson, And1, and Heelys saw its stock more than double on June 9, 2020. One day earlier, the stock soared 31% as more than 23 million shares changed hands.

2) Ideanomics (IDEX)

As of press time, Ideanomics’ stock was threatening to ditch its penny-stock status. The producer of group discounts on commercial electric vehicles and developer of financial technology products saw its stock rocket nearly 60% in early trading on June 9, 2020, nearing the $1 per share mark.

3) Exela Technologies (XELA)

Exela is a business process animation company with a market cap of about $100 million. The stock shot up 50% in early trading on June 9, 2020, trading around 65 cents a share by midday.

4) General Moly (GMO)

Founded in 1925, the Colorado-based mineral mining company saw its stock rise more than twofold from its late-March low of 14 cents to its June 9 close of 31 cents.

How do I find penny stocks?

Multiple investment websites offer screening tools which let you search for penny stocks based on parameters such as market cap, earnings per share, and revenue growth. You can also peruse the best penny stocks right here, with our monthly lists of top-performing penny stocks.

Visit this guide for more information on how to find penny stocks > 

You now have a better understanding of penny stocks. Click here to check out our next lesson, which will take you through technology stocks.

By Jonah Keri
Jonah Keri is a trader and analyst who spent 11 years at Investor's Business Daily covering the markets. He now writes about stocks, cryptocurrencies, and other investments for Invezz and about emerging technologies for private clients.
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