Of course, you probably don’t know anything about penny stocks anyway, so it’s okay. I’m here to educate you, young grasshopper.

When you think of penny stocks, you’re probably thinking about something like this:

terrible-penny-stock-ad

WHOPPING

These are the classic pump and dump schemes, which go a little something like this:

  • Dirtbags identify a small company with a compelling story.
  • They slowly buy a stake in said company for a few thousand bucks.
  • Then they use guys like Eric Dickson up there to promote the hell out of this “great opportunity”
  • This causes the stock to spike, going from something like $0.02/share to $0.20/share.
  • Dirtbag uses this opportunity to exit at an enormous profit
  • They move onto the next patsy company.

Even though there’s sometimes potential in these things (if you get in early enough and have the discipline to sell, which people never do), there’s no way you should put your money in some stupid penny stock scheme like this. That’s not investing, it’s speculating. Sure, there’s a certain amount of speculation involved with investing — because we can’t predict the future, at least very accurately — but investing involves reasonable guesses at a company’s future with tempered expectations, two qualities not usually associated with people trying to turn $5,000 in to $4.2 billion.

But this doesn’t mean that all penny stocks are bad. In fact, a majority of them are small companies just chugging along, doing their best to make widgets or rice or whatever it is they do.¬†Yeah, a lot of them are startups with fancy visions of building some cool new way to do something mundane (or completely weird stuff like attaching a camera to the International Space Station), but there are still plenty of conventional businesses to choose from.

Our hatred of penny stocks comes from the same place where our hatred of small-cap stocks comes from. Many investors aren’t trusting of any companies but the largest of the large, only investing in companies that they’ve either a) heard of or b) are big enough that there’s no way there could be any hanky-panky going on.

That’s the mistake most investors make when it comes to penny stocks. They group anything small into the “penny stock” subcategory, even though 99% of small companies (which usually have low share prices) have nothing to do with any sort of stock promoters.

Outperforming the market using exclusively large-cap stocks is hard. Like, really hard. Not only are you competing with a vast majority of investors (because most have a mega-cap bias), but you’re also competing with all the institutional money managers too. They’ve got morons on the bottom of the totem pole researching these giant stocks that are smarter than you or I. And you’re going to beat them, even though you have a job and a wife and kids who are terrible at hockey?

Sure, you could. And you might even beat the market. But if you do, it’s a fluke.

I’ll keep saying this until I’m kidnapped and forced to shut up because they stuff women’s pantyhose in my mouth. The easiest way for a retail investor to beat the market is to find small companies that the market has overlooked and institutional money can’t touch because they’re too small. There are a lot of smart investors out there who are kind enough to do a lot of the work for you, and publish their findings. And they do it for free. Either follow them, or do the digging yourself.

A big part of outperforming is also not being afraid to buy a stock that happens to only be trading for $1 or $2 a share. Look beyond the nominal value of each share, and look instead at the assets behind it. It never ceases to amaze me that an investor is happy to pay $1.20 for $1.00 of assets for a billion dollar company, but balks at paying 75 cents on the dollar for a million dollar company. Value is the important part, not the share price.

If you patently refuse to buy penny stocks, just go ahead and invest in an index. Because by only picking the biggest companies, that’s exactly what you’re doing. It’s awfully hard to beat the index by picking the same stocks in a different order. There’s plenty of value if you venture into the world of small and unusual companies. Some might even be penny stocks. Just remember, that as long as value is there, the nominal price doesn’t matter.

 

Tell everyone, yo!