Thursday, 11 November 2010

On penny stocks

(Mineral) Explorers often expect that raising capital is easier with a low nominal stock price. This opens the door to the realm of penny stocks.

Personally I don't favour penny stocks for several reasons:
- A low (penny) stock price is just an illusion, with the mask quickly torn off when you notice the number of stocks outstanding.
- Penny stocks don't trade more easily than other smallcaps or microcaps. Usually they trade by blocks of hundreds. Odd numbers are difficult to buy or sell. On TSX they have a low priority: the odd number fraction of buying orders gets filled only just before a tick down, that of selling orders just before a tick-up.
- An IPO issued at penny stock level rather points to a low self-esteem of the explorer or miner: they feel less comfortable in the company of big and successful miners.
- The perceived lower risk ("0 is the bottom") is illusory. When buying into penny stocks, you will inevitably buy a higher number, perhaps to the same or a comparable initial dollar position as you would with another stock. Your value at risk will also be comparable. Moreover, penny stocks quoting below 0.10 are up for a reverse split. This is often the start of another decline.
- Many penny stocks didn't start that way: raising capital under unfavourable conditions drove down the stock price, diluting existing shareholders into oblivion.  Management on this slippery slope has fully proven its incompetence.
- Several penny stocks evolve into "life style companies": exploration expenses on resources are lower than general expenses... until lack of funds halts any ongoing exploration project.  Management goes on drawing the remaining funds from the company without any useful return.
- A penny stock reputation is hard to break. Once down there, management needs to repeatedly overdeliver expectations. Large institutional investors won't come in upon the first good news.

Up for discussion... You can leave a comment.

1 comment:

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