Given such a low share price, there is an understandable draw for retail investors who dream of buying cent shares and seeing them rise to ten or more times that sum. But before dabbling into penny stocks, an investor should note several key factors that affect the way these stocks trade and to have a solid understanding of the inherent risks that follow.
One of the biggest mistakes that retail investors make is that they view penny stocks as being affordable. There is a sense that one is getting a better bang for their buck when they buy thousands of shares rather than a couple of a company with a higher share price. The key piece of information that is often overlooked is the number of shares outstanding. Here is the information in table for easier understanding:. For a better understanding of this topic, see: The Basics of Outstanding Shares and the Float.
Another factor to be conscious of when trading penny stocks is dilution. The number of shares outstanding can often balloon out of control through the use of tools such as employee stock options , share issuance in order to raise capital and stock splits.
If a company issues shares to raise capital, which many small companies need to do, then it can often dilute the ownership percentage held by other investors. When trading penny stocks it is important to find a company that as a strong grasp on its share structure because consistent dilution erodes the value of the shares held by existing owners. For further reading, see: The Dangers of Share Dilution.
Does the management team rely on issuing new shares to raise capital? Is the company profitable or will it be able to turn a profit based on its current business structure? Can the company compete in its sector? For those willing to do their homework there are definitely gems that can be found that meet these criterion.
As you can see from the monthly chart of General Growth Properties, Inc. Investors who kept an eye on the share structure, underlying fundamentals and competition could have identified GGP as a prime candidate and profited from a tremendous rise in the years that followed. The Lowdown on Penny Stocks. Another key factor to consider is that certain sectors are more common for finding stocks that trade under a dollar.
For example, the metals and mining sector is well-known of the number of companies that trade in the pennies. Given the reliance on issuing new shares to raise capital to fund operations, increased competition and aggressive incentive plans it's particularly important for investors to pay attention to the factors mentioned above in order to be successful.
When most retail traders look at a penny stock they often ignore underlying fundamentals, such as the number of shares outstanding. Share dilution hurts existing shareholders and it's particularly common with penny stocks. Keeping an eye on the share structure and other fundamental factors mentioned above will help investors find winners, such as HudBay Minerals and General Growth Properties. Spot Hotshot Penny Stocks.
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Share Price and Valuation One of the biggest mistakes that retail investors make is that they view penny stocks as being affordable. Here is the information in table for easier understanding: Beware Dilution Another factor to be conscious of when trading penny stocks is dilution.
The Bottom Line When most retail traders look at a penny stock they often ignore underlying fundamentals, such as the number of shares outstanding. No thanks, I prefer not making money. Get Free Newsletters Newsletters.More...