Many people know about stocks, and they know that stocks represent a share of ownership of a company. What many people do not know is that there are different types of stock, and some of the unregulated types appear to be excellent deals, but in the end costing the investor dearly.
Common Stock vs. Preferred Stock
Most shares of stock that are publicly traded are common stock. These are open to anyone to purchase, and function like what people typically expect. Each share of common stock comes with one vote when it comes to the yearly election of officers for the company, but has few other benefits.
On the other hand, preferred stock does not usually come with voting rights but does frequently have a set dividend. While technically preferred stocks are still equity shares, the fixed dividend payment causes investors to view them as a hybrid between bonds and common stock.
The exact definition of penny stocks varies among investors. Generally speaking, a small company with stock that trades under $5.00 per share is a penny stock. Investopedia has the best definition saying they are shares of a company are cheap and “highly illiquid and speculative.” Typically, penny stocks trade infrequently and trades of a few hundred shares can cause significant movements in price.
Pink Sheets and OTC’s
The New York Stock Exchange is host to many commonly traded stocks, and indeed provides the trading platform for many of the major companies. However, there are smaller companies that choose to issue shares, but not go through the trouble of getting on the exchange. These are called pink sheets or OTCBB’s (over the counter bulletin boards). These stocks are traded very infrequently, often they are valued very low per share, have limited public information and, hence, are quite speculative.
Large Losses Chasing Penny Stocks
In 2008 I read an article about a penny stock that was valued at $.0001 per share. The article claimed that the company was attempting to draw more investors, so they had planned to issue a dividend that was equal to around 50% of the stock value. The article went on to explain how the company could do such a thing due to the fact that they have been buying up shares at the low cost, and now they would again return to profitability. I went against my better judgment and invested $300, only to never see the dividend. After several years of the stock price remaining stagnant at $.0001 per share the company finally went bankrupt. I was able to claim a $300 loss on my taxes, but more importantly I learned a valuable lesson of do plenty of research, and if it looks too good to be true, it is.
Investing can be very rewarding. However, it can be the source of a lot of anguish and stress. To minimize the pain that comes with investing, it is often best to stick with the larger, more trusted companies with better information. Doing so may not provide those 1,000% returns seen in the paper every now and then, but it will prevent the numerous 100% losses the papers never report.