Tags: stock | large-cap | penny | mid-cap

An Alternative to Penny Stock Trading

By    |   Monday, 22 December 2014 08:44 AM

I hate penny stocks. But you've got to admit, they're enticing right? After all, you can buy a gazillion shares of something for under a buck per share.

One problem is that you typically own a whole lot of nothing, meaning they are unproven companies that typically haven't made any money and aren't likely to make any money for quite some time.

Then there's another problem. Many institutions aren't allowed to invest in stocks that are priced under $5 per share. Additionally, these stocks usually don't have enough daily volume for the "big boys" (mutual funds, pension funds, hedge funds, etc.) to be able to get into.

So the big money is never going to be there to push up the price of the stock and sustain a high price.

It's always going to be subject to the sleazy "pump and dump crowd." (You know, the ones that send out emails telling you why this next stock is the next Microsoft or Apple.) They buy the stock. Then they send you emails to buy it, which causes a ton of buying in the stock and then they sell out. It had ZERO to do with the fundamentals of the company.

And that's a problem.

However, there is a much better way to speculate on cheap stocks. Notice I still called it speculation rather than investing, because it does have you take on higher risk than does the average stock out there but it could also offer up a higher return.

Here's an example. Back in the 1930s, our country was in the Great Depression. Stocks were declining and some had gotten unusually cheap.

John Templeton took note of this and bought every New York Stock Exchange stock he could find that was trading for less than $1 per share (which would likely be closer to around $17 per share in today's money).

He took $10,000 and bought 100 shares of 100 stocks that were priced below $1 per share. Some companies completely failed while others did nothing. But the ones that took off did so well and made such a high rate of return that it more than made up for the losers.

Today, I want to show you a modern day version of something similar to this that is a much better way than buying the average penny stock out there.

Keep in mind it is speculating in stocks because it is high risk, but it could reap a well-above-average return too. And anything that's considered high risk should be done with a very small percentage of your overall net worth.

So here goes.

You can find cheap-priced stocks that still make money and have been around a long time. In fact, they can be quite large companies and many of them will be household names that you'll recognize.

They're what are considered to be large-cap stocks, which means that they have a market capitalization of $10 billion to $20 billion, or they'll be what are called mid-cap stocks, which tend to have a market capitalization of around $2 billion to $10 billion.

By dealing with companies of this size, you increase the odds that the company won't fail because they've been tested for a while through many market cycles and have grown to these huge sizes (unlike a the typical micro-cap penny stock that's worth less than $300 million or even worse, a nano-cap stock that is worth less than $50 million). While these may sound like large numbers to us as individuals, they are peanuts in the business world.

Additionally, many large institutions can invest in household name companies with large market caps that have a large amount of daily trading volume.

All you have to do is go to a stock screener website. In the screener, I only have to choose two things: 1) the market cap and 2) the stock price.

First I look for large-cap stocks less than $5. That produced four stocks in my screen. The second screen I do is to choose mid-cap stocks less than $5. This produced 18 stocks.

So between these two categories right now, there are 22 stocks that meet the criteria.

I'd suggest doing something similar to what Templeton did except I'd suggest putting the same dollar amount into each stock. So for instance, let's say you had $10,000 of money to play with and you wanted to buy 20 of these stocks. Then you'd buy $500 worth of each company. (If you had $5,000 to play with, then you'd put $250 into the 20 stocks).

Now that will end up being a different amount of shares in each company, but that's ok. You still own equal dollar amounts in each company. The key is you want a well-diversified basket of stocks. Don't just choose five stocks because any losers take up too much of the overall pie percentage wise.

Be willing to hold this basket of stocks for two to three years. You may not need to. They could produce huge gains for you in just a year. But be willing to hold them if needed.

Also, realize what Templeton realized. It's possible a few companies could fail and a few do nothing. But for the ones that take off to the upside, they're likely to have a much larger return, which would most likely cover the losers.

It will be up to you which stocks you choose and when you buy and sell them. I'm just handing you the idea.

Stick with large- and mid-cap stocks that are in the $2 billion to $20 billion range. Choose stocks that are less than $5 per share. Then you're dealing with cheap priced stocks that aren't small, dinky companies.

With these stock prices, you could have stocks go up 50 percent to hundreds of percent, which will help make up for any laggards or losers.

By doing it this way, you'll dodge the "pump and dump" crowd, you'll have stocks that have sufficient daily trading volume and you'll have stocks that large institutions can invest in.

Have fun with this trading idea.

God bless!

About the Author: Sean Hyman
Sean Hyman is a member of the Moneynews Financial Brain Trust.
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I hate penny stocks. But you've got to admit, they're enticing right? After all, you can buy a gazillion shares of something for under a buck per share.
stock, large-cap, penny, mid-cap
Monday, 22 December 2014 08:44 AM
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