What are penny stocks?
You might have heard of small caps, microcaps, stocks under $5, and many more, they are all synonymous used for penny stocks. The U.S Securities and Exchange Commission (SEC) defines penny stocks as a security or a financial instrument holding a financial value, issued by small public companies and is traded at less than $5 per share. Unlike regular stocks, penny stocks are priced over-the-counter (OTC) rather than on trading floors, allowing the trading to be performed directly between the buyer and the seller without any type of supervision. The lack of liquidity, public disclosure, and regulatory standards combined with price volatility and small market capitalisation do increase the risk associated with penny stocks.
In order to better understand the types of penny stocks, four different categories can be used:
|Category||Listings||Price (per share)||Standards|
|1||Major Stock Exchanges such as NASDAQ and NYSE||Priced below $5, can reach higher than at certain times||High Standards because the exchanges demand financial information|
|2||OTC||One cent to 99 cents||Low|
|3||OTC||Below a penny||Low|
|4||OTC||0.0001 to 0.0009 cents||Low|
Can a Cheap Stock listed on an Exchange be classified as a penny stock?
If you have been keeping up with retail investors from Reddit taking on Wall Street giants, you might have been aware of NOK or Nokia, a Finnish multinational telecommunications corporation. As of mid-February 2021, the company was trading between 4.10 USD to 4.17 USD being listed on NYSE. So, Is Nokia classified as a penny stock? The answer is NO. This is because a range of factors lead to a low share price for a reputable, large company meeting exchange standards.
Nokia is a 155-year-old company, operating in 100 countries with 100,000 employees and generating annual revenues of $24.98B in 2020. The NYSE and NASDAQ require annual fees, minimum market cap, and share price to list a company, all conditions met by Nokia. For a company such as Nokia, if the market capitalisation or price per share is too low, only then the company can delist from the exchange. In that case, the company is traded on the OTC market. The shareholders still own the shares but the worth of shares drops significantly.
Are penny stocks a good investment?
Penny stocks are riskier compared to regular stocks due to the high volatility and uncertainty associated with the companies. However, it is possible to obtain decent returns on your investments. Here are few factors to consider when identifying which penny stock to add to your portfolio:
- The company must be generating revenues and profits, companies losing money are always bad investments on the penny stock scale.
- Scalable business with ambitions and the right strategy in place to ensure the company aims to become a giant in its field in the future.
- Strong assets or cash and low amounts of debts. This ensures that the company can handle unpredictable events.
The additional risk and volatility associated with penny stocks do reduce the attractiveness. However, there are plenty of companies with potential if you can perform your due diligence and tolerate some level of risk.