3 Things Your Stockbroker Doesn’t Want You to Know About Penny Stocks

Few weeks ago, I got to discover that a friend of mine who lost her money in an investment in 2007. She came to me with a handful of circulars issued by that particular company regarding rights subscriptions to raise additional fresh capital. A quick check on its financial statements shows that the firm had been reporting annual losses since 2003 with the exception of 2007 when they recorded a tiny profit of $59,000.

Afraid of realizing her five-figure loss, my friend is still holding on to the penny stock till today. Her investment in Digiland International (SHX: G77), a distributor of electronic & information technology products and services, was triggered by her stockbroker’s recommendation.

The investment was recommended because her broker believed she could make a quick buck as Digiland’s stock price dropped from 6.5 cents to 4 cents. If the stock made its way back up to 6.5 cents again, she could net a tidy return of 62.5%! Unfortunately, Digiland is trading at 0.1 cents a share today.

While I believe the majority of brokers are responsible and look out for their clients’ interests , I’m extremely saddened by my friend losing her heard-earned money this way and I hope others would take this as an important learning lesson.

By definition, penny stocks are common stocks that are traded at low prices – below US$5 in the United States and below £1 in the United Kingdom. In Singapore, stocks that traded in cents are considered penny stocks.

Here are the 3 things you should know about penny stocks your stockbroker may not tell you:

#1 Penny Stocks are “Cheap” in Disguise

Similar to how consumer behavior is influenced by marketers pricing products at certain price points, psychological pricing in the stock market also influences us in one way or another. As a result, “cheap” penny stocks become very attractive to novice investors. The great danger is when one relies solely on stock price to gauge a stock’s value.

Let me give you a simple example using market capitalization: At this time of writing, SBS Transit (SGX: S61) is currently trading at S$1.70 per share while SIIC Environment (SGX: 5GB) is trading at S$0.18 per share. At first glance, SBS Transit looks ten times more expensive than SIIC Environment. A quick check would tell you though that SBS Transit is valued at S$523 million while SIIC Environment has a market capitalization of S$1.38 billion!

Does it sound cheap to you?

I think you got my point – price rarely equates to value.

#2 Penny Stocks are Often Targeted by Speculators

Low prices combined with billions of outstanding shares makes trading of penny stocks extremely easy. Because of that, punters like to use penny stocks as a means to speculate and gamble their money.

Blumont Group (SGX: A33) has a price chart that looks like a shark’s fin. The stock rose gradually from 3 cents to $2.50 per share in just 1½ years. Blumont’s stock was heavily manipulated and it subsequently crashed. Now the stock is back to square one and currently trading at 6 cents.

blumont-chart

Stock chart courtesy of Yahoo! Finance

The trio of companies, Blumont together with Asiasons Capital and LionGold Corp, made Singapore’s news headlines in October 2013 for wiping out billions of dollars in market value within a week.

Elsewhere in Malaysia, two stocks, VisDynamics and Solution Engineering also show a similar shark’s fin stock chart. These companies are classic cases of “pump and dump” where operators of the scheme will artificially inflate a stock’s price through false, misleading positive statements before selling them at sky-high prices. Unless you want to lose your pants, it’s better you stay out of this best you can!

#3 Penny Stocks Can Be Very Lucrative for Stockbrokers

Stockbrokers earn a commission from executing stock trades. There is nothing wrong with it as they do this for a living. However, if a stockbroker continuously lures you to buy and sell stocks for the sake of commissions, they are more likely to have their own interests at heart than yours.

So the next time when a broker tells you:

“This is the only chance for you to buy now before the share price skyrockets.”

You might want to respond:

“If it’s so good, why aren’t you putting your own money in it?”

I personally have very good brokers with me, and they generally they do not give any investment advice unless I specifically ask (which usually I don’t).

I have also heard cases of a rare breed of brokers who actually helped their clients make millions of dollars during a downturn. And hard to believe, these brokers also prevented their clients from trading in any stocks when there are no opportunities around. They clearly put their clients’ interests at heart. If you happen to know such a broker, good for you and continue to stick with them! A good, honest broker with your interests at heart is a valuable partner to have when investing.

[**New To Stock Investing? Get This Quick Start Investing Manual That’ll Show You How Anyone Profit From The Stock Market- Download Quick Start Investing Manual**]
Rusmin Ang is an equity investor and co-founder of The Fifth Person. His investment articles have been published on The Business Times BTInvest section and Business Insider. He has also been featured multiple times on national radio on 938LIVE for his views and opinions on how to invest successfully in the stock market. Rusmin is on the speaking circuit for CIMB Securities (Malaysia) and has spoken at events in Penang, Sibu and Kuala Lumpur and is the co-author of Value Investing in Growth Companies published by Wiley, Inc. The book can be found in all major book stores worldwide and on Amazon.com, Barnes & Noble and Apple's iBooks. Rusmin was actually a former SIAEC scholar who gave up his scholarship and a cushy career to follow his itch of learning how to be a better investor and ultimately lead a life of financial independence. He believes that anyone, even with a regular job, can achieve more financial peace-of-mind by investing intelligently and safely for the long term.

10 Comments

  1. Gregory

    June 24, 2014 at 6:46 pm

    Very good information! Thanks for enlightening on penny stocks.

    • Rusmin Ang

      June 25, 2014 at 4:37 pm

      Thanks Gregory! Glad you found the article useful! :)

      • Daniel

        June 28, 2014 at 4:35 am

        Very good info!

        • Rusmin Ang

          June 28, 2014 at 3:42 pm

          Hey Daniel,

          Glad you liked it too! :)

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  3. Sharon Loh

    July 21, 2014 at 2:32 pm

    Your article regarding Penny Stocks is very informative and I can see the many mistakes which I have made.

    On 2 June 2014, I have bought 70 lots of KOP at $0.30 on behalf of my mother. The share was recommended by my broker and I have checked out the Company before deciding to buy the share.
    KOP Properties is a developer with a diverse range of businesses from residential and commercial properties, hotels and resorts to yachts. Residential developments within its portfolio include the prestigious Ritz-Carlton Residences, Singapore, Cairnhill, and the multi award-winning Montigo Resorts, Nongsa.
    Atlas, Kop is trading at 0.255 lately and the price does not seem to be moving much thereafter.
    I will appreciate very much your opinion on this share.

    Cheers,
    Sharon Loh

    • Rusmin Ang

      July 22, 2014 at 11:18 am

      Hi Sharon,

      Could you share more information (told by your broker) that caught your attention and made you purchase KOP? For example, the company’s growth story, business fundamentals, targeted share price, etc.?

  4. Eugene@Shareinvestormalaysia.com

    August 21, 2014 at 2:48 pm

    Fully agreed with your 3 reasons Rusmin. But there are more reasons …hehehehe

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