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Penny Stock Returns

Why do people invest in penny stocks if they are so risky? The answer lies in a few facts as well as a few misconceptions about penny stocks.  First let us look at the positive side of how penny stocks can be more profitable.

It is a well-known fact in finance that risk and return have a positive correlation. This means that an investment that carries greater risk will also give higher returns. The reason for this is very easy to understand and is almost intuitive. Suppose you had $10,000 to invest and two options A and B. Option A is a secure government bond that gives you 5% return, while option B is a higher risk investment in a company that will pay you only if it makes profits. Assume that this company has a history of making 5% Profits over several years and is likely to continue on the same lines.

That is, you can expect to get a return of 5% in future years, but that is subject to the company making the same level of profits. Where would you invest your money? If the returns are likely to be the same and if you are a sane person, you would obviously invest in the risk free option. Now suppose, option B were to pay you not 5% but 15% consistently, you might be tempted to put your money in it. In other words, a higher return can make you to invest in a riskier venture.

Since penny stocks are higher risk alternatives compared to regular stocks, the only way they can attract investment is by holding out a promise of higher return. How would a penny stock offer a higher return? This will be done not directly by the stock or the company, but by market forces. The market price of a stock is fixed on the basis of a few factors such as its intrinsic value and the return yielded by it. The market price of a stock divided by the return it gives is known as the price-earnings ratio.

For example, if $10 stocks were to be traded in the market at $20, and the company earns a net income per share of $1, the price-earnings ratio is 20. The price-earnings ratio will be higher for solid stocks that are known to be backed up by good management, have a history of consistent and good performance, and are perceived to be stable. The price-earnings ratio for stocks that are riskier, unknown and do not enjoy a positive perception will be much lower.

This means that as against the example of price-earnings ratio of 20 that we assumed for a stable and well-known stock, a penny stock may have a much lower price-earnings ratio, say 3 or 4. Actual figures will depend on a number of other factors also.

Because of this, a penny stock will be priced lower for the same level of net income, and will therefore yield a higher return on the investment.
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16 comments:

  1. The question "why people invest in Penny stock inspite of the fact that it is very risky" is a question I battle with everyday.. Your article is an eye opener...life itself is a risk..

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  2. The promise of higher returns is everyone's desire when they are considering investing. Penny stock returns determines to a great return whether you will invest here or not.

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  3. The best investing tips for any one considering to do penny stock trading. You need such insightful information to make the right choice.

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  4. The price earning ration is very important in determining whether you invest in the market or not. It can greatly affect your penny stock returns if not well considered.

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  5. If I am not mistaken I have seen an overview regarding penny stocks a while back. Thank you for tackling this again. It would mean a lot to a rookie like me.

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  6. It is true that penny stocks is a risky endeavor but it could be profitable as well. One must have adequate stock education to be successful. Then it could yield good returns.

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  7. All these investing tips wouldn't be in vain. Whether I invest in penny stocks or not. I know I will certainly make progress with all these information gathered.

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  8. Thanks for the awesome article about stocks. I think i would really benefit from a free stock course being offered.

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  9. Thanks for the awesome article about stock. I think i would really benefit from a free stock course being offered i will have to follow up on this

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  10. Risk and returns have a positive correlation in finance. That's why people invest in penny stocks despite it being risky.

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  11. The fact that penny stocks are a risky investment strengthens the need to build a good foundation in stock education. That simple move can help lower the risk a bit.

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  12. Great investing tips as pertains to stock returns as usual. I keep notes of all this valuable info shared on this site.

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  13. Penny returns can be dismally low due to their low values. An active trader can however make it worth it by actively trading and seizing every opportunity to profit.

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  14. Penny Stock returns can be dismally low due to their low values. An active trader can however make it worth it by actively trading and seizing every opportunity to profit.

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  15. Penny stocks will always be a high risk venture due to how volatile the market gets. It needs a trader with a real tough skin.

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  16. Trading penny stocks all depends on when you enter the stock and how high it rises. If the stock doesn't rise or gain value you won't be making any money; however, it may be harder to sell the shares.

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