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A penny saved, a penny stock spurned


Q: I would like to learn more about penny stocks. Any information you can offer will be very much appreciated.

A: There's an old story about penny stocks that goes like this:

A broker calls his client, saying: "I have a terrific penny stock. It's selling for 10 cents a share, and I think it's going to go through the roof!"

Client: "OK, buy me 10,000 shares."

The next day, the broker calls back: "That 10-cent stock we bought yesterday is up to 20 cents a share, and I think it's going to go through the roof!"

Client: "OK, buy another 5,000 shares."

The third day, the broker calls again: "That 10-cent stock is now at 30 cents a share, and I think it's going to go through the roof!"

Client: "I don't care, sell!"

Broker (puzzled): "To whom?"

This little ditty describes one of the major risks associated with penny stocks -- illiquidity. These stocks are easy to buy but may be very hard to sell -- without negatively affecting the price.

Another risk of penny stocks is the spread. The "spread" is the difference between the "bid" price (the price to sell) and the "asked" price (the price to buy). If the spread is small, the risk is reduced, but penny stocks often have spreads of 25 percent to well over 50 percent of their purchase price.

Yet another expensive angle of the price of doing business in penny stocks may be the high commission rates. With stock buying and selling, generally the lower the transaction amount, the higher the commission as a percentage of the trade. And since penny stocks are so cheap, buying less than a $1,000 worth might mean paying the top commission rate, while buying more may make the stock harder to sell later.

The third risk with penny stock is the company risk. A penny stock may be a brand-new company, a small company, a company that just went public or a company that's been around for a long time. The company may be losing money, or it may be undercapitalized, or it may not be earning any money yet. A stock that declines in price may become a penny stock as a result of a recent disaster. In any event, there is usually a good reason the stock is so cheap.

Technically speaking, any stock selling for under $5 a share may be classified as a penny stock, although most penny-stock aficionados prefer to stick with the under $3 range.

If, after all my warnings, you decide to play this game anyway, I recommend you do some research on the companies. However, because these companies are generally small or have a small total capitalization, very few security analysts (if any at all) follow them on a regular basis.

One major publication that provides research on penny stocks and their markets is the Bowser Report -- a monthly publication with an annual subscription rate of $48. The address is P.O. Box 6278, Newport News, Va., 23606; telephone (804) 877-5979.

Penny stocks are like the little girl with the little curl right in the middle of her forehead. When they are good, they are very, very good. But when they are bad, they are horrid -- and you can lose everything. So, if penny stocks make your greed glands salivate, invest play money -- money you can afford to lose.

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