When it comes to investing, penny stocks are some of the riskiest bets out there. These are stocks that trade for less than $5 per share—and usually, there’s a reason they’re so cheap. The company might be on the edge of bankruptcy, or maybe it got kicked off a major stock exchange and now trades over-the-counter (OTC). Some penny stocks belong to brand-new companies with little track record, which makes them even harder to evaluate.
By nature, penny stocks are extremely volatile and prone to price manipulation. But every now and then, one pays off in a big way. For instance, if you had bought shares of Monster Beverage (MNST) back in 1996 when it was just a penny stock trading at 1 cent, you’d be celebrating today—it’s traded over $60 in 2024.
If that kind of wild upside excites you, diving into the world of penny stocks might sound tempting. But before you do, let’s talk about how to approach them wisely.
Always Check the Fundamentals First
Before investing in any penny stock, you need to do your homework. Just because a company used to be successful doesn’t mean it’s a smart buy today. Take Walter Energy, for example—it was once trading at over $140 per share in 2011. But when its stock plummeted to just 16 cents, some investors saw a bargain. Sadly, the company soon went bankrupt, and those investors lost big.
On the flip side, Inovio Inc. (INO) traded at just $1.08 in mid-2008. In the years that followed, it climbed above $10 multiple times, giving investors plenty of chances to lock in profits.
What’s the difference? The fundamentals. Walter Energy was in the coal business—an industry that was already declining, especially as global leaders pushed for lower emissions. That, combined with an oversupply of coal and falling demand from China, spelled disaster. In the end, the company sold off its assets in 2016.
Inovio, on the other hand, is a biotech company working on cancer vaccines. It has strong partnerships and potential for a big buyout. While that hasn’t happened yet, the stock has seen big swings and stayed in the $6–$12 range in early 2024.
Bottom line? Look at things like debt, cash flow, market potential, and competitive landscape before you invest in any penny stock. Understand why the price is low in the first place—don’t just chase a cheap deal.
Also Read: Should You Reinvest Dividends or Take the Cash?
Know Where the Industry Stands
Beyond the company’s numbers, it’s also smart to look at where the industry itself is in its life cycle.
Some penny stocks are in industries still in the “pioneering phase.” This is the very early stage where many small startups compete with brand-new ideas and very little customer demand. Think of early tech or biotech companies—high costs, low sales, and a lot of uncertainty. That’s why their stocks trade so low.
Then comes the “growth phase,” where some of these companies break out. During the late 1990s tech boom, for example, many startups that began as penny stocks saw explosive growth as investors jumped on the internet bandwagon. Of course, many of them also crashed when the bubble burst.
Penny Stock Hotspots: Binary Industries
Industries where companies either boom or bust—what some call “binary outcomes”—are full of penny stocks. Biotech and resource sectors are the biggest examples.
Back in the 2000s, Canada’s TSX Venture Exchange was filled with resource-based penny stocks that soared during the commodity boom. But when the market cooled, most of them crashed hard—just like many tech stocks during the dot-com crash.
Still, if you know what you’re doing, there’s potential to profit when conditions are right. Just remember: these stocks can fall just as fast as they rise.
Also Read: What’s the Difference Between Growth and Value Stocks?
Why Management Matters (A Lot)
In real estate, the golden rule is “location, location, location.” For penny stocks, it’s “management, management, management.”
A strong, ethical, and experienced leadership team can make all the difference—whether it’s saving a struggling company or driving a startup toward big success. When management owns a solid chunk of the company’s stock, that’s often a good sign—they have skin in the game.
Of course, top-tier managers are rare in the penny stock world. But there are exceptions. Look at Concur Technologies. After the dot-com crash, its stock dropped to just 31 cents. But by 2014, the company was bought out at $129 per share. One key reason? The leadership of Rajeev Singh, the President and COO, who co-founded the company and held several important roles until its sale to software giant SAP.