How Is Penny Stock Investing Approached By Professionals?

Many investment firms and their brokers have discouraged penny stock investing. A penny stock is one that trades for less than $5 a share and are generally considered bad prospects for future growth or value. These stocks are typically of companies that are in reorganization or have experienced financial difficulty. However, a company whose stock trades below $5 may have some hidden potential and their share price may represent an undervalue relative to its book value.

Penny Stocks

Penny stocks have been touted by certain investment and brokerage houses that have been subject to fraud investigations and other scrutiny. Known as boiler rooms, these companies have engaged in sales practices that have led to changes in rules and regulations regarding the offer and sale of penny stocks. These rules have shied many brokers away from offering them to their client, except in cases where a client requests that a particular penny stock be sold to them.

Penny stocks have received a bad reputation due to the fraudulent activities of a small number of brokers and their firms. Purchasing or owning a penny stock does not violate securities law and may provide some value for an investor’s portfolio, depending on the circumstances for the company’s stock to trade below $5.

Potential for Penny Stocks

Some brokers and investment professionals approach penny stocks from the position of potential. Applying the same sound principles for analysis and review of a company and its stock, an investment professional can determine the future prospects for the company’s stock. A professional will review the company’s financial statements and review the reasons why the company’s stock has fallen. In some instances, a company’s stock becomes a penny stock due to the cyclical nature of the business. Toy companies, for example, see dramatic changes in their stock price during the course of year. Toy manufacturers receive the maturity of their profits in the last quarter of the year toward the holiday season.

In this example, the company itself may be a good value for an investor. Understanding the company’s financials and determining the long-term prospects for growth may make the penny stock a good value. Looking beyond the reputation for penny stocks and analyzing a company’s potential on its individual merits will help you find value in investing in these companies. An investor should perform the same level of due diligence when researching penny stocks as they do for other types of stock investments.

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