What Does 2017 Hold For Penny Stocks?

By Alex Dumortier, CFA Markets Fool.com


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If you're reading this, then there's still a chance I'll save you money this year -- perhaps a lot of money -- if you're thinking about gambling on penny stocks. And I use the term "gambling" deliberately, as there's no sense in which buying penny shares can be considered investing.

What does 2017 hold for penny stocks? The same things we witness every year in this part of the stock market: fraud, market manipulation, and, ultimately, massive losses for the naive individual investors who wander into this swamp.

Don't think of penny stocks as stocks

Penny stocks are different from ordinary common stocks -- in fact, investors ought to think of them as different animals altogether. The easiest way to recognize them is that they're generally priced below $5 per share (often less than $1) and typically trade over the counter. They belong to very small companies, and the SEC hasn't vetted the stocks' offering documents.

There are good reasons the SEC requires brokers to wait two business days after having sent clients a warning statement regarding penny stocks before executing any trades on their behalf. They do this for the same reason casinos in the United Kingdom used to require punters to wait 48 hours between taking out a membership and being able to place a bet: to allow people a breathing period in which to take the full measure of what they're getting themselves into.

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Of course, speculating in penny stocks is different from betting in a casino. In fact, the odds on penny stocks are much worse than those for any game you'll find in Las Vegas, and their promoters are less scrupulous than any Vegas pit boss. With penny stocks, the table isn't stacked against you; instead, the penny-stock promoter has lugged the table up to the top floor of a tall building, pushed the table off the side of the building, and is waiting for it to land on top of you.

Penny stocks aren't investments -- they're aren't even good speculations

Benjamin Graham, the father of value investing and mentor to billionaire investor Warren Buffett, wrote: "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

With penny stocks, the promise is not of safety of principal, but rather its massive impairment. As the SEC emphasizes in its warning statement titled "Important Information on Penny Stocks," "Investors in penny stocks should be prepared for the possibility that they may lose their whole investment." "Possibility" is a generous hedge in this context.

There is such a thing as intelligent speculation, but gambling on penny stocks doesn't fall in this category, either. The potential return doesn't come close to offering adequate compensation for the risks incurred. The only people who ever became rich on penny stocks are their promoters.

A sample from this year's crop of penny-stock frauds

I wrote a similar article to this one a year ago, in which I urged readers to steer well clear of penny stocks in 2016. These are just a sample of the headlines relating to penny stock frauds that have surfaced since then:

  • March 23: "SEC Charges New York Man With Conducting Penny Stock Manipulation Schemes"
  • March 29: "Former TV Commentator Settles Penny Stock Fraud Charges"
  • Sept. 26: "SEC Charges CEO and Boiler Room Operator With Fraud"
  • Sept. 30: "SEC Charges Alleged Penny Stock Manipulators"

In the last case, telemarketers were paid a commission as high as 10% to 20% of their sales, while assuring their patsies they received no commission. The company in question had "scant revenue and no real legitimate business prospects."

You're miraculously lucky

You're interested in penny stocks, and by some miracle, you found your way past the countless disreputable penny stock-related links on the internet to this article. Do yourself a favor and capitalize on your good fortune by forgetting about penny stocks. Take that decision today, and I can assure you that you'll finish the year happier and wealthier than you would if you persist in pursuing this folly.

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