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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 – blow 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.

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.

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Robin Han
Rusmin Ang

Rusmin Ang is an equity investor and the co-founder of the online investment magazine The Fifth Person. He is also the co-creator of The Investment Quadrant, an online multimedia stock investment course where students can learn how to invest profitably in the stock market. Rusmin has been featured multiple times on 938LIVE as a guest expert on MoneyWise and is on the speaking circuit for CIMB Securities (Malaysia) and has spoken at events in Penang, Sibu and Kuala Lumpur. Rusmin is also the co-author of Value Investing in Growth Companies which is internationally published by Wiley, Inc. The book can be found in all major book stores worldwide and on Amazon.com,Amazon.co.uk, Barnes & Noble and Apple's iBooks. If you're interested to learn more about stock investing, you can join The Fifth Person Newsletter and receive free weekly insights on how you can generate higher returns and dividend income from the stock market.