Last week, I warned people not to make dumb decisions in the face of financial pressure. Many readers took issue with me for warning people about penny stocks, accusing me of "large-cap chauvinism."
Here's my scathing condemnation: "Even people who love penny stocks often end up burned by them; these tiny equities can be easily manipulated by hypesters, and the companies to which they're tied often lack established track records."
The Securities & Exchange Commission (SEC) has some cautions of its own: "Before a broker-dealer can sell a penny stock ... The firm must furnish the customer a document describing the risks of investing in penny stocks." It adds, with its own italics: "Investors in penny stocks should be prepared for the possibility that they may lose their whole investment."
The researchers have spoken
Financial researchers have known for years that penny stocks carry above-average risk with no guarantee of good returns. A 1998 study by researchers P.J. Seguin and M.M. Smoller looked at nearly 6,000 Nasdaq stocks between 1974 and 1988, and found not only that lower-priced stocks were more likely to fail than higher-priced ones, but also that investors earn lower returns on lower-priced stock portfolios, once you adjust for risk.
Penny stocks are so risky in part because their prices are more subject to manipulation. In a 2006 study, Rainer Bohme and Thorsten Holz found that penny-stock spam e-mails could significantly affect share prices, at least on a short-term basis.
These aren't pennies...
You might think that all stocks started out as penny stocks. But don't let the historical prices of strong performers fool you. Take a look at these stocks:
| Company | 20-year avg. annual return | Split-adjusted closing price, 8/11/1989 | Actual closing price, 8/11/1989 |
|---|---|---|---|
| Target (NYSE: TGT) | 13% | $3.82 | $60.00 |
| Best Buy (NYSE: BBY) | 29% | $0.22 | $6.38 |
| CVS Caremark (NYSE: CVS) | 10% | $4.88 | $33.83 |
| Wal-Mart (NYSE: WMT) | 13% | $4.32 | $41.00 |
| EMC (NYSE: EMC) | 29% | $0.10 | $5.13 |
| Oracle (Nasdaq: ORCL) | 22% | $0.44 | $17.87 |
| US Bancorp (NYSE: USB) | 10% | $3.21 | $25.62 |
| Microsoft (Nasdaq: MSFT) | 24% | $0.33 | $57.75 |
Data: Yahoo! Finance.
It might look like Target was a penny stock way back when. But that $3.82 has been adjusted to reflect stock splits. The shares were actually trading at $60 then -- far from penny territory.
Plenty of high-quality small-cap stocks trade at respectable prices. But when it comes to penny stocks, regardless of how big the company may be, you can count me out.
Do you agree or disagree? Let me know by leaving a comment in the box below.
No comments:
Post a Comment