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Asking—and
understanding— before making the investment is a smart move.
A penny stock is the term used for a share that typically sells
for less than $5. Since the number of shares you receive when you
make an investment depends on the price per share, the same amount
of money invested in penny stocks will buy a much greater number
of individual shares. For example, if you are investing $200 in
a company with a share price of $10, you will receive 20 shares.
If, on the other hand, you are investing the same $200 in penny
stocks with a value of $2 per share, you would receive 100 shares
of that company.
There is a popular belief that because you own more shares you will
make more money if the price goes up, but in reality you are investing
the same amount of money in both cases, regardless of how many shares
you own.
The main problem with penny stocks is the lack of regulation by
the Securities and Exchange Commission (SEC), the federal agency
that oversees the stock market. Penny stocks are not required to
register with the SEC or to abide by its reporting rules. That makes
the information about these stocks very unreliable. In fact, they
are usually discussed in chat rooms and blogs without much substance
to their facts.
Another red flag for penny stocks is the lack of buying support
behind them. Institutional investors, such as mutual funds, pension
plans, investment companies and insurance companies do not buy them.
These mega buyers of the stock market invest millions of dollars
at a time in the market and they choose companies with the best
prospects for gain, not obscure little companies that are flying
under the SEC radar.
When you look at the initial share price of the most profitable
companies in market history, such as Microsoft, Cisco Systems, Wal-Mart,
Home Depot and many others, you will find that none of them started
as penny stocks. These promising corporations joined the big leagues
from the get-go by competing in the regulated marketplace.
If you want to invest in stocks, you have over 10,000 companies
from which to choose that offer you the numbers and track record
on which to base your investment decisions. You will indeed end
up with more shares when you purchase penny stocks, but the ultimate
outcome may unfortunately turn into a worthless collection.
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