10/2/2013 8:15 PM ET|
The real danger of 'cheap' stocks
Investors who focus on nominal share price are at best wasting their time and at worst exposing themselves to huge risk.
Being a glutton for punishment, I try to be accessible to readers and fellow investors via Twitter and email.
And while the most common notes I receive are either about typos in my work or the stupidity of my investment decisions, another common message sent my way is in regards to "cheap" stocks.
I'm not talking about valuations here regarding price-to-earnings ratios or discounted cash flow analysis — I'm talking simply about whether a stock trades for $1 or $100 a share.
Unfortunately, investors who focus on nominal share price are at best wasting their time and at worst exposing themselves to huge risk.
Share price simply does not matter — the quality of your investment does. And the sad reality is that most stocks with a cheap share price tend to be of a lesser quality.
Here are the many reasons a focus on "cheap" stocks can be the most expensive mistake you ever make.
Penny stocks are the playground for scams
Some folks fall in love with the fast-paced world of penny stocks and microcaps, but the horror stories in this space are all too common. Consider the unscrupulous "stock tips" from celebrities like rapper 50 Cent on Twitter, or Notre Dame football legend Daniel "Rudy" Ruettiger charged by the SEC in a pump-and-dump scheme in 2011. And more recently, read about an August penny stock bust that involved a $140 million fraud ring across 35 countries. This is the crowd you're running with when you go for microcaps that trade on the pink sheets.
Cheap stocks have often fallen from grace
What about legit stocks on the NYSE that trade for $5 instead of 5 cents? Well, let's be honest… no stock trades for $5 because it's red hot. Stocks that are doing well go up and not down. Right now some of the biggest (by market capitalization) stocks in the single digits include the battered National Bank of Greece (NBG), barely break-even drugstore also-ran Rite Aid (RAD), and troubled chipmaker United Microelectronics (UMC). All have losses that top 50% across the last 10 years. Sure, they might go up from here… but will likely never reclaim past valuations.
Turnarounds are highly uncommon
People like to hold up the example of Apple (AAPL) with its return from the brink as the case of a turnaround play that made investors millions. But if you think geniuses like Steve Jobs and iconic companies like Apple are common among $5 stocks… well, think again. Turnaround stories more typically end up with an ending similar to the current narrative at BlackBerry (BBRY).
Cheap stocks don't go up faster
Consider Priceline.com (PCLN) traded for $600 a year ago and now trades for over $1,000 share for a 60% gain in 12 months. That included a 21% run in about three weeks this May. So don't tell me expensive stocks can't move big in short order.
You can buy one share
Let's say you had $600 to invest a year ago and bought 240 shares of the Sirius XM (SIRI), the cult stock of bargain investors everywhere, for about $2.50 a share. It's now at $3.80, so you're sitting on 52% gains… not bad! But you also could have bought one share of Priceline at $600 — there's no minimum on shares, remember — and made over 60% gains instead.
Do the math
Just to belabor this: 240 shares of SIRI x $2.50 per share = $600, and 1 share of PCLN at $600 per share = $600. And then, 240 share of SIRI x $3.80 = $912, and 1 share of PCLN at $1,000 = $1,000. Which is the better investment?
Most shares aren't Priceline
But what if you have less than $600 and want to invest? Well consider that only 12 stocks on the entire NYSE and Nasdaq (out of more than 4,300 issues) trade for more than $400 a share. That's a mere 0.3% of your investing options — hardly a big deal. And hey, only 150 stocks or so trade for $100 or higher. That's 3.5% of your investing options.
You can buy partial shares anyway
What if you simply just HAVE to buy a pricey stock like Priceline.com? Well, a host of online brokers often provide access to "fractional shares" … so you can buy a half a share or less instead.
Maybe you shouldn't be buying stocks, anyway
So if you only have $100 to invest and if you have your heart set on Priceline.com, you can still buy it. But why in the world would you? Your broker may charge you fees as high as $10 a trade — and charge twice, mind you, since you get hit on both the purchase and the sale — so you need a 20% gain just to recoup the cost of trading.
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Well! That was nice article, but Penny Stocks can be fun and there are plenty of examples of $100 stocks dropping to $1 and so many, I won't list examples. Life is risky!
The important thing to remember is the investment pyramid. Good solid stuff at the base and at the tip you can play with silly stocks. Not a lot, just a bit. And my silly example is PHOT. It sells for about 5 cents a share and they make Grow-Lights and Hydroponic Equipment. CO and WA made pot legal and soon other states will become envious of the tax revenue, and make pot legal. Prices for POT will be outrageous and everyone will want to have their own little Pot Garden and then GrowLife (PHOT) will begin ringing up sales. Just look at booze, gambling, lotteries! The morals are dropping in all the states and worse in DC. Probably before not to long they will all make prostitution legal and I am sure some enterprising young ladies will build cat houses right next to all the State Capital Buildings where most their customers work.
A nickel a share and I bought 10,000 shares so if it only goes to $1.05 I made $10K. And if I lose my $500 I can write it off against my other income.
Right now, PHOT is my favorite silly stock!
The difference between a Casino and the Stock Market is the Stock Market wheel keeps spinning until you tell it when to stop. This makes the odds a wee bit better.
A lower share price is a psychological factor in determining whether or not it appears as a "fair price."
Historically, that's why most issues will declare stock splits.
The most advantageous stock price in my opinion? $15 to $25 per share.
The time for a stock split? $50 and over.
Berkshire Hathaway's high stock price? That's a "prestige" stock, and to keep the little guy out.
If Apple split its stock to $20 per share, it would probably climb to $30 easily based upon appearance alone.
You missing the real reason penny stocks are dangerous. And that is there is no volume, sure you can buy penny stocks cheap, but try and sell the same stock after it has supposedly gone up 50%, and you will find that there are NO buyers. No actually Buyers, its all manipulation.
You are generally right on with the article however...... a $5.00 stock is a $5.00 stock for a good reason, no one believes in the company.
There are examples where sub $5.00 stocks such as Sirius do well. Sirius should be much higher but there are so many shares around , which is the reason it still only $3.83. It was .60 cents because the stock was diluted, not because it was a particularily bad company if you took a look at it 3 years ago when myself and apparently Speed Guitar saw it.
Most penny stocks are much smaller companies with little volume, meaning no buyers and no sellers, you buy....your stuck until one day maybe the stock gets hot through news or some newsletter promotion. Good Luck with that
As with all stock investments, you need to do your research, starting with the prospectus, income statement, balance sheet, & cash flow statement- basic stuff that many either ignore or fail to even look at. You will expose yourself to great risk if you ignore these basic starting points.
Markets aren't happy right now, what's it fallen to;< 15,000 now? I foresee a buying opportunity either around 3 PM or when markets open tomorrow. If your in this just for the money (I know you are Fat Cat) you should be able to pick up some nice bargains.
One last observation: If the government furloughs only amount to < 14% of the government work force, couldn't we just cut 10% off the top of the government expenses that are NON-ESSENTIAL during this hard time for the economy ? The government could always add in them in later if they truly needed them.
And V_L: Our trout fishing spot near Hendersonville N. C. is not in a national forest so your free to dig for the worms there for my youngest without prosecution from the forest rangers.
1 800 FU*KYO that's what the numbers spell out... man you can't make this stuff up!!
now tell me this isn't the biggest F.U. to the American public by that black muslim thug pig sleaze in the white house and his filthy liberal democrapic ilk...and some stupid story on 'cheap stocks' is a clossal joke compared tothe outrage each American should feel about the utter and outright disrespect it has to the American public, the taxpayer who's outta work because of THEM!!!...leaving out of course you pig smug arrogant vermin liberals, pathetic little viDICtive vermin at that you are anyway....you're THE PROBLEM to begin with!....this is beyond the pale of outrage actually, I can't believe that this is what the nation has come to!!....and if you think for one second that, that pig obama didn't have anything to do with that hotline number spelling out those very words..F. U. than you're hopelessly lost in stupidity, denial and ignorance....
hmmmm ain't this interesting,
'Critics say Maduro is continuing a Chavez-era tactic of inventing crises to divert focus from economic and social ills affecting the South American nation's 29 million people. '
---- 'invent crises to divert focus...' now I ask you people out there, (not you liberal vermin obama-lackies this ain't for you) does that sound familiar to you? now WHERE have I heard that before! (never let a crisis go to waste) hmmmm....
I now return you to your 'cheap' stock whatever nonsense was the topic...something or other....
Futures exchanges, such as Euronext and the Chicago Merchantile Exchange, trade in standardized derivative contracts. These are options and futures contracts on a whole range of products. The members of the exchange hold positions in these contracts with the exchange, who acts as central. When one party goes long (buys a futures contract), another goes short (sells). When a new contract is introduced, the total position in the contract is zero. Therefore, the sum of all the long positions must be equal to the sum of all the short positions. In other words, risk is transferred from one party to another. The total of all the outstanding positions at the end of June 2004 stood at $53 trillion. (source: (BIS): ). That figure grew to $81 trillion by the end of March 2008 (source: BIS )
Tailor-made derivatives, not traded on a futures exchange are traded on over-the-counter markets, also known as the OTC market. These consist of who have traders who in these derivatives, and clients such as [look it up]. Products that are always traded are [look them up]. The total of all of the outstanding positions at the end of June 2004 stood at $220 trillion. (source: BIS: ). By the end of 2007 this figure had risen to $596 trillion and in 2009 it stood at $615 trillion. (source: BIS: )
US: Figures below are from SECOND QUARTER, 2008
According to "$516 trillion at the end of June 2007"
Positions in the OTC derivatives market have increased at a rapid pace since the last triennial survey was undertaken in 2004. Notional amounts outstanding of such instruments totaled $516 trillion at the end of June 2007, 135% higher than the level recorded in the 2004 survey (Graph 4). This corresponds to an annualized compound rate of growth of 33%, which is higher than the approximately 25% average annual rate of increase since positions in OTC derivatives were first surveyed by the BIS in 1995. Notional amounts outstanding provide useful information on the structure of the OTC derivatives market but should not be interpreted as a measure of the riskiness of these positions. Gross market values, which represent the cost of replacing all open contracts at the prevailing market prices, have increased by 74% since 2004, to $11 trillion at the end of June 2007.
Notional amounts outstanding as of December 2012 are $632 trillion as per recent survey. (BIS)
CRAZY`8;What are you smoking?39 straight months of job growth and a market up 90%.
Did you like the market down 37% with GWB.It`s amazing how stupid the far right is.
James 1954:Nothing like starting the day off with a big right wing conspiracy.Did you hear
Obama actually shot Lincoln.
If these right wingers who are always crying about Obama and hate the country so much
should move to Russia.There`s no chains on Americans.I retired 2 years ago because I
became a millionaire with market skyrocketing.If you didn`t participate in the market, blame
yourself for being stupid.The far right spends 24/crying and bellyaching.We`ve got 39 months
left of Obama`s peace and prosperity.MAN UP !
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