What is a Penny Stock?

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Contributor, Benzinga
December 20, 2023

Penny stocks consist of corporate stocks that have a very low cost — maybe not just a penny, but quite low compared to the stocks of most listed companies. Many of these stocks trade in the over-the-counter (OTC) markets, which means that they trade through a network of brokers and dealers and not on a centralized stock exchange. With that noted, some stocks that are technically penny stocks can be found listed on major exchanges, such as New York Stock Exchange (NYSE).

What is Considered a Penny Stock?

The current correct definition of a penny stock is any stock priced under $5. Some stocks lose their market value when the issuing company’s business declines or it approaches bankruptcy. They sometimes lose enough value to eventually become penny stocks, which is the reason that some penny stocks trade on major exchanges.

Marathon Oil (NYSE:MRO) is a good example of a stock becoming a penny stock. It was trading at over $13 per share in December 2019, but the stock since fell to hit a low of $3.02 in March 2020. Marathon Oil eventually staged a dramatic comeback and briefly reached $33/share in November 2022. While Marathon Oil is just one example among many penny stocks, the majority of them are issued by small or new companies without a track record to generate investor interest. Such stocks could still have considerable upside potential depending on the company’s product or service.

What Penny Stocks to Buy

Investors can choose from many penny stocks. However, some of these stocks are better than others. Penny stocks are risky, and they can gain or lose substantial value within short periods of time. Investors should look at each company's financials and industry. Some companies operate in high-growth industries. A rising tide can lift all ships and help penny stocks in promising industries appreciate over time.

Technical analysis can help investors find short-term opportunities but looking at fundamentals can reveal enticing long-term investments. Investors can also look at hedge fund trading activity and see which penny stocks the experts are accumulating.

List of Best and Worst Penny Stocks Right Now

The best penny stocks generally have a solid balance sheet and either already show a profit, or will potentially show profits in the near future. Also, many prominent foreign companies list their stocks on the OTC Bulletin Board to avoid the steep listing fees charged by major U.S. stock exchanges.

Foreign companies’ stocks that trade on the U.S. over-the-counter market include the Japanese holding conglomerate SoftBank (OTCMKTS:SFTBY) that has a market cap of over $60 billion and Nestle SA (OTCMKTS:NSRGY) with a market cap of roughly $300 billion.

The worst penny stocks typically don’t disclose their finances to shareholders and don’t have the obligation to report their earnings or other financial aspects of the firm. These stocks trade on the Pink market, and can often be risky investments.

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Pink Market Stocks

The Pink market — formerly known as the pink sheets because quotes were printed on pink paper — is operated by OTC Markets Group, which also operates the OTCQX and OTCQB markets, an OTC bulletin board that shows you everything not listed on the traditional exchanges.

Companies listed on the OTCQX and OTCQB markets are obligated to provide the U.S. Securities and Exchange Commission (SEC) with key financial information and be current on their disclosure, while companies listing their stock on the Pink market have no obligation to file with the SEC or to disclose their finances to investors.

You cannot see the trading volume for these stocks (or know that it’s current/correct). You may not see reporting of individuals who are involved with these businesses, and you may not see the current market value of the business because it is not reporting to the SEC as the listing standards do not apply.

You may also encounter shell companies that are designed for mergers (SPACs) that are trading on the OTC until they can list on a traditional exchange, giving you easier and cheaper access to a unique equity security.

How to Quickly Identify a Penny Stock

The general criteria for a penny stock is the stock of a very small company trading under $5 per share. This makes identifying penny stocks pretty easy, although some exceptions do exist as mentioned above. Remember, the Securities and Exchange Commission does not label penny stocks, it merely requires reporting

Sorting penny stocks into different categories can further narrow down your choices when doing research. For example, you might look for stocks under $3 per share, penny stocks listed on major exchanges, or penny stocks traded on the Pink market.

Best Online Brokers for Penny Stocks

Many online brokers now offer their stock brokerage services free of charge for stocks listed on major U.S. stock exchanges. Due to liquidity issues and the lack of a centralized marketplace, however, most brokers charge a commission for penny stocks and require a minimum share purchase amount. Make sure you know how much your broker charges for penny stock transactions before you begin penny stock trading. You can start your search for a good broker to trade penny stocks through by looking through the table below.

Are Penny Stocks for You?

Whether penny stocks are for you or not depends largely on your risk tolerance. While the market volatility of penny stocks can be considerably higher than that of regular listed stocks, your downside risk is limited to the purchase price. This amplified risk is due to the nature of penny stocks since they are often either stocks of companies facing financial difficulties or stocks of small, new companies without a performance track record or proven profitability.

Even with the risks involved, you can gain great rewards from trading penny stocks. For example, Amazon (NASDAQ:AMZN) stock was once a penny stock that traded at $1.50 per share in June 1997, and you could still buy the stock under $6 per share in September 2001. Having the foresight to purchase Amazon at those low levels would have provided quite a handsome return. Shares now trade at roughly $140/share after a 20-for-1 split. At the same time, you cannot expect to make millions on a lucky penny stock. It’s better to find the right share price, use a brokerage with favorable commission pricing, make the right penny stock trades for your strategy and build your portfolio organically.

You may find it challenging to find another gem that performs like Amazon among the thousands of penny stocks you can trade. Still, if you do diligent research and manage to identify an industry with strong future prospects, you could find the next Amazon.

Frequently Asked Questions

Q

Are penny stocks risky?

A

Penny stocks are riskier than most types of stocks. These investments can quickly gain or lose market value and require a high risk tolerance.

Q

Can you make money buying penny stocks?

A
Yes, it is possible to make money in penny stocks, but it is also highly risky. Penny stocks are typically low-priced stocks of small companies with limited liquidity and less regulatory oversight. While some investors have experienced quick profits through trades or buy-and-hold long-term penny stocks, the majority of these stocks are highly volatile and can lead to substantial losses. It requires thorough research, careful analysis, and a high tolerance for risk to have a chance at making money in penny stocks.
Q

Is investing $100 in penny stocks worth it?

A

Penny stocks are risky, but $100 can grow substantially if you pick the right penny stock. Investors who are considering penny stocks should only allocate a small percentage of their portfolio to these stocks. Investors should consider their risk tolerance and financial goals before buying penny stocks.

Luke Jacobi

About Luke Jacobi

Luke Jacobi is a distinguished professional known for his role as President at Benzinga, a renowned financial media outlet. With a background in business operations and management, Luke brings valuable expertise to his position, overseeing various aspects of Benzinga’s operations. His contributions play a crucial role in the company’s success, ensuring efficiency and effectiveness across different departments. Prior to his role at Benzinga, Luke has held positions that have honed his skills in leadership and strategic decision-making. With a keen understanding of the financial industry and a commitment to driving innovation, Luke continues to make significant contributions to Benzinga’s mission of providing high-quality financial news and analysis.