If you’re looking for a bargain on the stock market, or you have little money to invest, penny stocks can be a tempting venture. After all, with a low barrier to entry — by definition, $5 or less per share — penny stocks may seem like a safe way to invest your money.
But don’t be fooled. When it comes to penny stocks, the old saying couldn’t be more true: you get what you pay for. Cheap as they are, penny stocks have dubious prospects for growth, not to mention low market valuations, and if you’re looking to build wealth, penny stocks aren’t the “rags-to-riches” venture many make them out to be.
So, before you start adding penny stocks to your portfolio, let’s take a step back. What are penny stocks, and are they truly worth the money? Let’s look closely and see.
What are penny stocks?
Penny stocks are small companies whose market capitalization is between $50 and $300 million (aka a micro-cap company) and whose stocks trade for $5 or under.
Penny stock companies are typically young, small businesses (usually start-ups) with a little fire but no proof their business model will work, or their products and services will catch on. They usually don’t have a cash reserve to support them. They may rely heavily on debt, or depend on unproven technology that they hope will propel them forward. Whatever the reason for their small size, penny stock companies often take huge risks to get off the ground. When you invest in them, you’re essentially betting the company will do the impossible and overcome these major challenges.
And it’s a steep bet. Penny stock companies often fail. Unlike growth stock companies, which are fast-growing companies with potential for success, it’s doubtful penny stock companies will exhibit long-term growth. You can lose money on a growth stock venture, sure. But the danger with penny stocks is losing your entire investment, as these companies can easily go bankrupt.
Can you get rich off penny stocks?
Penny stocks are, well, stocks. As such, you can earn money by investing in them. That said, it will be a real challenge if you expect to earn significant wealth, let alone get rich, on penny stocks alone.
To understand why, consider the most common way penny stock investors make money: short-term gains. Unlike growth and value stock investing, which involve looking for companies that will demonstrate long-term upward growth, penny stock investors want companies that will hit it big in a short period of time. When that spike comes (if it does), the penny stock investor typically sells their shares to make a quick gain.
The problem with this? For one, we’re talking about penny stocks. Even if a penny stock worth $5 hit a 100% gain, you’d still only earn $5. To get rich off penny stocks, you have to trade at high levels, and even then you probably won’t earn as much as you would in a good growth stock.
The second problem is consistency. You may earn a quick profit off a handful of penny stocks, but rare is the investor who can do this frequently over long periods of time. Those that do are professionals, meaning they invest significant amounts of time and money (even professionals lose) in penny stock ventures. Unless you’re prepared for that kind of investing style, you shouldn’t expect to earn wealth off penny stocks alone.
If you have extra money and you want to try penny stocks, by all means — give it a whirl. But if your goal is to invest for retirement, or you’re new to investing, penny stocks aren’t the smartest option for you.
How can you find penny stocks?
Because of their size, most penny stocks don’t meet the requirements to be traded on major market exchanges, such as the TSX. Instead, penny stocks are sold over-the-counter (OTC), such as on an over-the-counter bulletin board (OTCBB) or on “pink sheets.”
When a penny stock company is listed on an OTCBB, it has to meet certain requirements. For instance, it must keep up-to-date information on its finances, and it must make financial records available for traders to review. Pink sheets are a different story. When listed on pink sheets, penny stock companies don’t have to reveal information on their finances. For this reason, buying penny stocks on pink sheets is considered extremely risky, as you won’t know much about the companies you’re buying.
How can you trade penny stocks in Canada?
Since penny stocks are traded OTC, you’ll have to find a broker who will buy and sell penny stocks on your behalf. Many will do this, but check your online brokerage ahead of time if this is something you’re interested in.
Once you have a broker who will conduct penny stock trades, you buy penny stocks as you would normal stocks: fund your account, choose your penny stock company, and place an order.
Because of the risks that penny stocks impose, you typically may have to sign a disclosure with your broker before you start buying them. They’ll usually send you a document detailing the risks, and once you review and sign it, your broker will allow you to trade penny stocks.
Finally, if you’re serious about trading penny stocks, make sure your broker doesn’t charge commissions on penny stock transactions. Since you probably won’t earn much on penny stocks anyway, you don’t want to give away your precious gains to extra investing fees.
What are some good penny stocks in Canada?
In Canada, you’ll likely find the majority of penny stocks in the following markets:
- Oil & gas
While we don’t recommend penny stocks as a principle investing strategy, a few companies could be viable for beginning investors. Here’s just a few penny stocks that have crossed our radar.
- Cloud MD Software & Services (TSXV:DOC) is a company specializing in telemedicine. Riding on “shelter in place” mandates from the pandemic, this company has demonstrated impressive growth over the last few years. It’s currently expanding its virtual health services, which may help it grow even more.
- Fire & Flower Holdings (TSX:FAF) is a cannabis retailer that has a potentially lucrative relationship with convenience store giant Alimentation Couche-Tard. Though the cannabis market is admittedly saturated with new businesses, this partnership with Couche-Tard gives Fire & Flower a competitive edge, as the former could help the cannabi retailer with retail management and eventual expansion.
- StorageVault (TSXV:SVI) owns and operates around 180 self-storage properties all over Canada. Though it may not seem like an exciting business venture, the current shortage of storage units is propelling this business’ growth.
What’s a better alternative to penny stock investing?
A better approach to stock investing, especially for beginners, is to invest for the long-term. That means finding high quality stocks, such as undervalued stocks, good growth stocks, or even stocks that pay out consistent dividends, and holding on to them for the long-haul. Additionally, you could diversify your portfolio by investing in a solid fund, such as an ETF.
Another alternative to penny investing is to buy fractions of a stock. You may not have thousands of dollars to buy a full share of Shopify or Amazon. But with fractional investing, you can buy a small amount and still benefit from the company’s growth.