How To Buy Penny Shares

The Motley FoolA recent article in the Business Times caught my eye. It was about penny share fever in the Singapore stock market.

The writer pointed out that on one particular trading day some 9.4 billion shares worth around S$1.7 billion were traded. That would suggest the average price of each share bought and sold was just 18 Singapore cents.

That got me thinking.

I know it when I see it

Although there is no formal definition for a penny stock, I suspect most of us know what one would look like if we saw one. Or as US judge Potter Stewart once remarked about pornography: “I know it when I see it“.

Penny shares, as the name suggests, are shares whose price is just a handful of cents rather than several dollars. In Singapore, the average price of a share is around 40 cents.

In the Straits Times Index (SGX: ^STI), the median price for Singapore’s blue chips is roughly $4.50. In the midcaps it is about $1.30. But down in the small caps they tend to be around $0.20. And amongst the Catalist stocks, it is just $0.10.

Many people mistakenly believe that just because a penny share price is already so low, it cannot possibly go any lower. Consequently, they feel that the only way for these shares must be up.

How low can it go?

In reality, though, the reverse might be true. Any share can fall to zero, which means that you could lose all your money. In fact, penny shares are probably more likely to do this because they are smaller companies and they also tend to also be in riskier sectors.

Thing is, just because the share price is so low does not automatically give it more potential to rise. Instead, it is how the company will perform that determines this.

It is also worth bearing in mind that the cost of dealing can be proportionately higher too. This is because the spread, which is the difference between the buy and sell price of penny shares, can be significantly wider than for larger companies.

Penny shares, it should be noted, are also more prone to rumours because of their small market valuation. Their price can move more easily because only a handful of shares might be traded.

But it is important to remember that rumours are just that – rumours. So, if you own penny shares, you may find that their market value may gyrate for no reason other than because someone might be spreading tales about the company.

Boring blue chips

Whenever I think of penny shares, I am reminded of a story about Bob, a private investor.

Bob, you see, felt that blue chips were a little boring. In his mind, he could not see the attraction of buying a stock that only returned around 8% a year. (Oh dear. If only Bob knew that such an investment could double in value in around nine years.)

So, Bob decided he would chance his hand on a stock tip he got wind of at a local coffee shop. It seems that a little birdie told him that a particular penny stock was set to explode into life.

So at the first available opportunity, Bob phoned his broker to place an order for one lot. As it turned out, the shares rose sharply. So, a delighted Bob phoned his broker to buy more.

It could be you

His broker advised him against it. But Bob was adamant. And sure enough the shares rose even further. Every time the shares rose, Bob would be on the phone straight away to buy even more. And every time that he did, his broker would warn him against it.

Then one day, the shares fell.

So, Bob quickly called his broker to sell his holdings. However, his broker was unable to find any buyers.

A perplexed Bob asked his broker why he couldn’t find a buyer for his shares. After all, there must have been plenty of buyers out there since the shares had risen so sharply previously.

Not really“, his broker replied. Then came the shocker. “You see, Bob, the only person out there buying the penny shares was you“.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.