Penny stocks. Don’t even go there!

By Josh  August 23, 2018

There comes a time in every new investor’s life when they become disenchanted by the “boring” returns of blue-chip stocks and government bonds. Sure, those are known for modest growth potential and steady dividend payments (income), but they are boring! They are what your grandpa invests in! I want to do something cool, and get rich quick!!

Enter Penny Stocks.

Penny stocks have an air of mystery about them. As the name implies, these are companies whose share prices trade in the pennies or fractions of pennies, compared to one share of Apple which is now $215 per share or Amazon which is $1900+. That’s a pretty high barrier to entry for a novice investor. The problem is, buying just a few shares of a no-name company doesn’t get you anywhere, so the novice will still throw a good chunk of change at a penny stock and wind up with thousands of shares of these companies.

I had a couple modest successes with penny stocks, and some utter failures! One company that you might remember seeing on TV commercials and sponsoring your favorite sports team (they literally had ads on hockey rinks, baseball stadiums, and agreements with several NFL teams) was “SpongeTech”. This was an innovative idea, where you would buy a normal-looking sponge for your household or automotive cleaning needs, but the soapy stuff was already inside the sponge! As they say – just add water! Well the idea may have seemed real, but the company wasn’t. I initially bought shares around 4.3c each, about 12 thousand shares for $500. Then the price dropped to around 3.5 cents a share, so I doubled down. Now I’m holding about 25 thousand shares of this “company” with a cool product, and with major endorsement deals all around pro sports. I was going to ride this rocketship “to the moon” (which is something all Penny stocks are supposedly going to do…)

The stock eventually took off. 3-4 cents suddenly became 7 cents. Then 12. Around 15cents per share I started selling some of my shares, to recoup my initial investment. But this thing just kept going and going, so I threw all of my money back into SPNG and was hoping to swing for the fences. I was going to place a limit sell order for 25c per share on a big lot of my holdings, and one day during my lunch hour it breezed past 25 and was at 27 cents per share! I had a public hearing that afternoon, so I wasn’t able to keep tabs on the action, but I had an excitement inside me to see if we would hit 30 cents per share by the time the hearing was over.

And that’s when my first major penny stock went bust. I entered my meeting at 27 cents per share (and holding about $15k in stock of a worthless company), and I left the meeting with about $4k in stock, in said worthless company. My heart sank, I had a lump in my throat, all of the cliche things that mean someone is having a bad day, happened to me that afternoon. I was freaking out! I *lost* $11,000 in one 2-hour meeting. And the stock would continue to bounce around, trailing ever lower as time went on. It turns out the CEO was a fraud, constantly offering up more shares, diluting existing shareholders so he could continue to fund his lavish lifestyle. SPNG eventually got de-listed and traded on Over The Counter (OTC) exchanges as SPNGQ (trust me when I say a Q in the stock ticker is bad, unless you’re invested in QQQ – the ETF that tracks the Nasdaq 100).

Meanwhile, given my early success with SpongeTech, I was constantly looking for another possible big winner. I grew up in Indiana, so when I found an Indiana-based company, I probably gave them more credence than I should have, because Hoosiers are known for being trustworthy, hard-working, honest folks. Environmental Enzymes Solutions (EESO) sold “green” cleaning products before that was a cool idea. They sold these chemical concoctions in gallon jugs, not anything that would look cool on store shelves, so they were going more for commercial and industrial cleaning companies.

What piqued my interest on EESO was a press release that said a South Korean company had offered to buy the company for 10 cents per share. Well, at the time I read that article, EESO was trading for 2 cents per share! I loaded up my proverbial truck and waited for word that the company would accept the South Korean offer. This was an easy opportunity to earn 5x my original investment!!! But as time went on, the share price dipped, so I bought more. Then it fell some more, and I bought some more. Eventually I could buy about 40,000 shares for a dollar, and I owned nearly ten million shares. Well the company was continually diluting and selling more shares. The buyout offer, if it was ever real at all, was for BEFORE the dilution started, so there was never any chance of receiving 5x my initial buy-in.

My EESO experience taught me two great lessons: Do your homework, and Beware of the Pump & Dump. Pump & Dump is slang for a news article or press release being sent out to pump up the share price with some exciting news about the company or stock, meanwhile earlier investors (who bought cheaply or just want to sell their stock) wait for the inevitable run-up from this press release, then dump their shares into the open market.

I bought some other penny stocks that were biopharma companies waiting on the coveted FDA approvals of Phase 3 clinical trial results (that would never come), in which case the share price would go up between 10x and 50x. Others were upstart (not startup) bank stocks, which was a pretty dumb moved while 465 banks were closed by the FDIC between 2008-2012.

All-in-all, it was a good education on the way individual stock trading works, but it was an expensive lesson for me at the time. Most of this happened in early 2009, when the stock market was just reversing and heading back up at the start of the current bull market. If I had bought undervalued REAL companies at that time, many of my investments would be up 10x or more, assuming I held them to present day. I pretty quickly got out of my fascination with turning a fast profit, and I actually got out of all individual stock investments a year later.

It wasn’t until I took Bridget Casey’s Six Figure Stock Portfolio course in 2017 that I bought another individual stock, as I attempted to earn some extra side income in the form of stock dividends. I’m an Index Fund investor for 99% of my invested funds, and will probably remain that way for a looooong time. But seriously, if you have any interest in investing in individual companies, or just want to understand investing better, hit up Bridget’s course and save yourself the THOUSANDS of dollars I spent on my penny stock investing fiasco. It will pay for itself hundreds of times over, in the long run. Even for index fund investors like myself, you will better understand asset allocations and having a plan as your portfolio grows.

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