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When stock markets are weak, many investors see an opportunity to make some money in penny stocks. And I am one of them, but cautious too.
In the last 12 months, the FTSE 100 it’s been flat mostly. So the 2023 drop thus far is really the opposite of the late 2022 gains.
But look at the small cap FTSE index. During the same 12 months, it lost 13%. Lucky for some? Maybe.
He AIM home to many very small growth stocks, the index has fallen a whopping 24% in the same period.
risk and reward
So there is a higher risk of losing money with small-cap stocks, including penny stocks, than with big blue-chip stocks. But I’m sure most people accept it.
But the opposite has to be true. If they tend to fall more in bad times, surely they will win more in good times, right?
It doesn’t matter if the value is £10 billion or less than £100 million. If a company looked good last week and its share price falls this week with no bad news, surely it must be better value now.
Long-term
Looking at the charts again, this time over 10 years, is revealing. The FTSE 100 has achieved a 16% gain in a decade. But the small-cap index is up 58%.
The AIM index is curious. For 10 years it has only done 9%, but has had much bigger spikes from time to time. By April 2021, for example, AIM shares were far ahead, up 75% compared to Footsie’s 9%.
So looking for penny stocks to buy when they are clearly down can be a money-making strategy. But I do think it needs a lot more care, in some key areas.
Resilience
rolls royce suffered in the covid accident. That is a large FTSE 100 company, and it had the clout to raise the cash it needed to survive. Now it seems to me that it is ready to prosper.
But a small business can find it much more difficult to raise cash when times are tough. Some of the worst I’ve seen have had to rely on issuing more stock, year after year after year.
I won’t name my worst example, but it issued massive amounts of new shares and brought the price down to a fraction of a cent. Those who bought on the IPO have lost 99.99%.
Clean?
So yes, a very small company faces more risk of going bankrupt in a bear market. Or, at least, diluting its shareholders to almost zero.
Even without a slump, debt doesn’t sit well with penny stocks. And I don’t like ‘jam tomorrow’ with no profit yet either. I avoid them, unless I see plausible profit forecasts.
So for me it all comes down to one key thing. And that’s being much more critical of the financial state of a small company than a large one.
This is why I buy very few penny stocks. But when I see one that I think is super cheap, I’m in.
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