The Tycoon Report

Should You Invest in Penny Stocks?

Monday, March 26, 2007 | Jason Jovine

I decided to speak a little bit about the topic of penny stocks today because every single day, I receive e-mails or occasionally a letter from people who are pushing their penny stocks.

Having worked on Wall Street, as well as having lived in Queens, NY most of my life, I can make out a huckster within about two seconds.  Let me say that generally speaking, well over 90% (I am probably being conservative here) of these no-name penny stocks are nothing but hot air, and you shouldn't even tell your worst enemy to invest in them.

Once in a very blue moon, there may be a penny stock worth looking at, but these are few and far between. 

I will say that these penny stock pushers sure do get creative.  One time, the subject line in the e-mail said, "Great White Shark Spotted in Florida".  I opened it out of curiosity since I moved down to Florida several months ago, not to mention the fact that I try to get to the beach as much as I can, and guess what?  That was just a hyped up title to get me to open the e-mail to read about some crappy penny stock.

Why do they push these stocks on us?

The short answer, as is the case most of the time, is money.  These penny stocks are usually traded on the pink sheets (http://www.pinksheets.com/index.jsp) or the bulletin board (http://www.otcbb.com/).

They are usually very thinly traded.  In other words, there is very little activity or liquidity with these types of stocks.  The smallest amount of buying or selling could significantly knock these stocks up or down.  In other words, they are highly speculative.

As I always say, and I want you all to remember, risk and reward always go hand in hand, and penny stocks are no exception; they carry a ton of risk.

The people who push unsuspecting investors to buy penny stocks can be the actual management of the company itself and/or an outside investor who bought a lot of shares of the penny stock at a very low price (e.g. 1 or 2 cents a share.)  They want you and as many people as they can get to buy it so as to knock up the price so that they can sell their positions and take their profits.  It is kind of like a pyramid scheme.

Many times, the e-mails that are being sent out pushing these stocks come from other countries (e.g. Russia) and many times, organized crime can be behind the scenes orchestrating this fraud.  They just push a button and blast these e-mails to hundreds of thousands of people.  Even if .0001% of the people open them and buy the stocks that they are suggesting, then it is worth it for them.  That said, stay away from these deals.

Change your thinking?

One thing about human nature that is irrational is that many investors focus on quantity instead of quality.  In other words, time and time again I have spoken with investors who, for some reason, would rather buy, say, 1,000 shares of a $10 dollar stock instead of 100 shares of a $100 stock.

In either one of these two cases, you have $10,000 invested.  I would guess that the $100 stock is "probably" a better company than the $10 stock, but, for some reason, human nature tends to make us believe that the lower priced stock represents a bargain.  I am telling you to change your thinking.

If you invest $10,000 in whatever stock, it is still $10,000.  What you need to focus on when you invest is which investment has the lowest risk and highest potential reward; it's that simple.

If the returns on your portfolio are just not cutting it, and you are looking to kick start your portfolio, you would be better off trading options.  Before doing that, though, I would strongly suggest learning and understanding them.

Options can be an excellent way to give your portfolio that extra kick.  You don't have to be a cowboy with options.  I heard a person a long time ago say, "Options are like eating an ice cream cone in a sauna."  I agree with that to a certain extent, but that is overly simplistic.

Options can be risky if your don't understand them, but if you do, you know that there are many conservative as well as speculative option plays.

In closing....

Stay away from penny stocks unless it is a really special situation, and if you are looking for the extra kick, then learn about stock options.  I have mentioned in a past article that we are currently working on an options education product; stay tuned.

Finally, don't be lazy about it.  Many people think options are too complicated, etc.  Trust me, if I can learn about them, you can, too.  If I were to spend 15 minutes on the phone with anyone, they would at least understand the basics.

It is your money, folks, and you are working so hard to make it (most of you, anyway.)  Know what you are investing in, and take the time to study up on options; this isn't rocket science.

Until the next time, folks, spend your hard-earned money wisely.

Jason Jovine
Contributing Editor
The Tycoon Report


 
Editor's Note:  Several readers let us know that they could use more clarification on what these various economic announcements really mean to them.  We hope that adding the "implications" section to each announcement below will help!  The "Mark Your Economic Calendar" portion that we re-print (thanks to the good folks at Briefing.com) every Monday might be the driest reading you'll find in The Tycoon Report, but a professional investor never starts his or her week without knowing what announcements are on the horizon that could affect their positions.  And hey, we don't think you should either.
 
 
Monday, March 26
 
10:00 - New Home Sales: Consensus 995k
 
Big Picture:  New home sales are down 32% from the peak in July 2005, with strong year-end gains offset by an even stronger January plunge.  National Assoc of Realtors expects the bottom in Q3 2007.   We expect a slightly stronger sales pace once the Spring season gets underway as gains over 4 of the last 6 months reflect growing stability.  Lower fixed term mortgage rates, lower prices, and the strong underpinnings of earnings growth and a low unemployment rate provide the underlying trend.  Median prices are lower than a year ago, but prices will improve as unsold inventories are thinned.  Inventories reached a high of 7.2 months in July and October and have fallen off since.  Strong speculative buying in some locations leave a stronger risk of larger price declines (in those specific locations) as the trend in national and regional prices will be extremely modest compared to the size of the increase over the prior few years.
 
Implications:  The home sales report is quite volatile and subject to huge revisions, making any one month's reading very unreliable.  The report rarely prompts a market reaction.  The market prefers the existing home sales report, which has a sample data pool four times as large and is released earlier in the month.
 
 
Tuesday, March 27
 
10:00 - Consumer Confidence: Consensus 109.0
 
Big Picture:  The index reached a new five-year high in February.  Tame energy prices, long term yields, and the tight labor market added to a resilient economy.  The index has been extremely volatile over the last year.  Mini 'cyclettes' (and large monthly volatility) are evident in the slowing upward trend.  The index is presumed to provide an early read on consumer spending which is far better previewed through interest rates and income growth.
 
Implications:  The Conference Board conducts a monthly survey of 5,000 households to ascertain the level of consumer confidence.  The report can occasionally be helpful in predicting sudden shifts in consumption patterns, though most small changes in the index are just noise.  Only index changes of at least five points should be considered significant.
 
 
Wednesday, March 28
 
8:30 - Durable Orders: Consensus 3.0%
 
Big Picture:  Durable goods order growth has slowed (2% yoy) as business capital investment has stalled since the start of the second half of 2006.  Flush corporate balance sheets, high capacity use, and rising exports remain strong underlying factors as reduced demand tied to auto and housing add to slowed capital investment.  The measure is volatile given the large costs of the goods included -- planes, capital goods and defense provisions.  But now business confidence plays a larger role in directing the pace of capital investment and the strength of the manufacturing sector.  A sustained downturn seems unlikely given the roaring pace in early 2006, and inventory downsizing explains some of it as the underlying fundamentals and expectations for continued moderate economic growth in 2007 should provide support.
 
Implications:  The durable orders release measures the dollar volume of orders, shipments, and unfilled orders of durable goods (defined as goods whose intended lifespan is three years or more).  Orders are considered a leading indicator of manufacturing activity, and the market often moves on this report despite the volatility and large revisions that make it a less than perfect indicator.  These problems can be minimized by looking at the breakdown of orders.  The total number is often skewed by huge increases in aircraft and defense orders.  An increase based solely on strength in one sector tends to be discounted, while the market is more impressed with broadbased increases in orders.
 
 
Thursday, March 29
 
8:30 - Initial Claims: Consensus NA
 
Big Picture:  Initial claims are tracking a gradual rise as the boost in February faded just as the January dip did.  The recent levels suggest some loosening in the labor markets as the 4-week average reached a 16-month high in early March.  Continued claims are on an upswing as well with the weekly level at a 14-month high the same week.  Provides a nearly real time read on the labor market as the low 4.5% unemployment rate reflects the broader measure of net hiring.
 
Implications:  Initial jobless claims measure the number of filings for state jobless benefits.  This report provides a timely, but often misleading, indicator of the direction of the economy, with increases (decreases) in claims potential signalling slowing (accelerating) job growth.  On a week-to-week basis, claims are quite volatile, and many analysts therefore track a four-week moving average to get a better sense of the underlying trend.  It typically takes a sustained move of at least 30K in claims to signal a meaningful change in job growth.
 
8:30 - GDP Final (Q4 '06): Consensus 2.2%
 
Big Picture:  A large downward revision to Q4 leaves the last three quarters with average growth of just 2.3% as the Fed targets some potential growth (3%) to slow inflation pressures.  The forward risk is that sluggish manufacturing demand holds longer than expected, and on the upside that growth will outpace potential growth as the housing effect fades.  Lower energy prices aided Q4 growth by boosting consumer spending and slowing imports.  2006 growth was based on moderating consumer spending and the strong decline in housing as slowing business investment was bumpy.  2007 growth will be based on a more stable housing market as consumer spending remains stable and business investment provides a risk.  Inventories are currently overbuilt, but adjustments won't be severe after the firm Q4 slowing.  Stimulative fiscal policy contrasts with restrictive monetary policy as economic growth has softened but remains self-sustained.  Inflation risk is weakening as the slowed economy helps quell the pressures.  Little slack in the economy and remaining inflation risks are the Fed's concerns.
 
Implications:  Gross Domestic Product (GDP) is the the broadest measure of economic activity.  Annualized quarterly percent changes in GDP reflect the growth rate of total economic output.  The figures can be quite volatile from quarter to quarter.  Inventory and net export swings in particular can produce significant volatility in GDP.  The final sales figure, which excludes inventories, can sometimes be helpful in identifying underlying growth trends as inventories represent unsold goods, and a large inventory increase will boost GDP but might be indicative of weakness rather than strength.  The broad components of GDP are: consumption, investment, net exports, government purchases, and inventories.  Consumption is by far the largest component, totalling roughly 2/3 of GDP.
 
Quarterly GDP reports are broken down into three announcements: advance, preliminary, and final.  After the final revision, GDP is not revised again until the annual benchmark revisions each July.
 
 
Friday, March 30
 
8:30 - Personal Income: Consensus 0.3%, Personal Spending: Consensus 0.3%
 
Big Picture:  Consumer spending rebounded in Q4 as the drop in energy prices left fuller pockets.  2007 got off to a stronger start than expected.  While we expect spending to run at a more moderate 3% pace, it will be the key element of slowing in overall economic growth given its dominant weight (70%) in GDP.  Strong employment and improving income growth provide underlying support as wages and salaries are 5% higher yoy.  The Fed's favored core PCE price index edged back to 2.3% yoy in January from a 2.4% yoy peak in August.  The Fed seeks a core PCE rate below 2%. 
 
Implications:  Personal income measures income from all sources.  The largest component of total income is wages and salaries, a figure which can be estimated using payrolls and earnings data from the employment report.  Beyond that, there are many other categories of income, including rental income, government subsidy payments, interest income, and dividend income.  Personal income is a decent indicator of future consumer demand, but it is not perfect. Recessions usually occur when consumers stop spending, which then drives down income growth.  Looking solely at income growth, one may therefore miss the turning point when consumers stop spending.
 
9:45 - Chicago PMI: Consensus 49.5
 
Big Picture:  The Chicago PMI is a regional manufacturing survey that closely mirrors the ISM (Institute for Supply Management) Index.  The big picture description and implications are quite lengthy, so if you're interested in reading more, just click here.
 
10:00 - Construction Spending: Consensus -0.6%
 
Big Picture:  Vastly different factors drive the 3 components of construction spending:  residential, business and public spending.  Business structural investment has surged over the last year and leads the components in yoy growth.  Residential spending is plunging and stands -13% lower than a year ago.  Public spending is motoring along at 12% yoy.  Residential provides more than half the weight in the index and leaves the overall measure in decline at -1.2% yoy.
 
Implications:  The monthly changes are both volatile and subject to huge revisions, so this report rarely has any market impact.  Only trends extending over three months or more can be viewed as significant.
 
10:00 - March Michigan (Consumer) Sentiment: Consensus 88.8
 
Big Picture:  The push to a two-year high in January is largely tied to the drop in gasoline prices as the recent equity drop and renewed fear about recession and sub prime mortgage lending has left some fall off.  The tight labor market and resilient economy continue to support the upward trend.  The expectations component has surged 17% since the August high in gasoline prices.  The University of Michigan survey is significantly smaller (500 phone calls) than the Conference Board's, includes a longer outlook (for expectations) as questions are focused on the household compared to the business heavy CB survey.  The index far better tracks the consumers' mood than spending habits better indicated through interest rates and  income growth.
 
Implications:  Closely mirrors overall consumer confidence numbers from the Conference Board.  Like the Conference Board index, it has two subindexes - expectations and current conditions.
 
 
Source: www.briefing.com