We’ve all heard of penny stocks. The SEC defines a “penny stock” as low-priced shares of small companies that typically trade infrequently, generally over the counter and not on a stock exchange. It is sometimes difficult to find price quotes on these companies and to obtain accurate pricing. They’re the cheap stocks that we can actually afford to have a few of and hope we can make a rather quick turn-around on.
But some of them are actually used to scam people out of their previous funds. How? Scammers talk up some thinly traded securities on message boards and to their social media networks, even through blogs and emails. They talk about how well-priced they are, how great the companies are (clean energy and gold are keywords that can really generate interest) and claim that they’re the ‘next best thing’ or the ‘best kept secret’ in the market (this is commonly called the ‘pump’).
Once the securities are artificially pumped, the scammers sell their shares right away and run with the money, leaving investors bereft when the stock price goes back down (this is called the ‘dump’).
How to avoid these back stocks?
- Don’t go for stocks that aren’t traded on one of the major exchanges
- Avoid companies that have less than $10 million in annual revenues
- Do not listen to emails talking up specific companies in penny stock trades
- Avoid companies in industries that you don’t understand or may not be comfortable with
- Buy companies at a very low multiple on their cash flow (no more than 6 times)
- If there are no financial statements listed, stay away
These types of scams are rampant and can be very damaging to investors. Every time that something new and exciting pops up on the market, you can be sure that there are scammers ready to take advantage of it so make sure that you first do your due diligence before investing in a new stock.
In any case, and as always…
Always make sure that you make an informed decision in all cases,
All the Best,