Penny Stocks Earnings Claims – Too Good to be True?

I have been a trader for most of my adult life, which to date has been 52 years. I have traded a variety of investment vehicles at both the institutional and retail levels. In short, I have a pretty good idea as to the nature of trading. Which is not to say that I know everything about trading, that would be a tall order to fill.

Penny Stocks Earnings Claims

But something has been bothering me lately, and it’s the outrageous claims that purveyors of penny stocks are claiming. In looking advertisements for these stocks this morning I came across some astounding claims; one firm promised 3000% return on their stock investments, another firm touted a 900% return on their investment choices, and yet another firm claimed day 1200% rate of return on their investments. Common sense tells us that returns that border on astronomical are highly unlikely. After all, if it were possible to attain these returns why are all investors not fully invested in these investment schemes?

Penny stocks are generally traded on the “pink sheets” and thus are not subject to the stringent reporting requirements the principal exchanges require. For this reason, stockbroker’s are allowed to make claims that would otherwise be illegal for members of the New York Stock Exchange or the NASDAQ to publish. Of course, you do not see member firms of the major exchanges touting outrageous rates of return on their investments; it is simply not allowed.

So why do these penny stock firms tout such extraordinary rates of return on some of their investments? The answer is a simple one; because they can. These fantastic rates of return are designed to entice unknowing investors into plunking their hard-earned money down on these risky stocks, which are among the riskiest investments in the investment continuum. Depending upon which a scientific study you read, 8 out of 10 of these stocks fail within two years of going public. Granted, a few stocks perform quite well, but discerning exactly which stock will skyrocket in price is dicey business. It is difficult, at best, for even the best penny stock firms to determine which stock will turn in excellent performance.

So I object to the use outrageous claims that these stock firms trumpet when advertising their services. The truth be told, these stocks are among the riskiest investments you can make and the vast majority of this class of stocks end up the worthless. In my opinion, these ads are misleading and would have the unsophisticated investor believe that all penny stocks are real moneymakers. Nothing could be farther from the truth, and I feel like purveyors of this class of stocks should disclose this fact to potential investors.

Further, there can be some irregularities in the actual trading of these penny stock issues. Since they are traded on the pink sheets, there is often a question of who is making a market in these issues. Often times, the firm making the market in these stocks is also the firm buying the stock back from investors. This is, of course, a bona fide license to steal. Oftentimes, there is a wide gap in the bid and ask prices when buying and selling these stocks. The differential between the bid and ask prices is little more than pure profit for the firm involved in buying and selling the stock. As I have said, the same firm may, in fact, be both buying and selling the stock simultaneously. So the spread between the bid and ask price is often pure profit for the firm involved.

On a final note, many penny stock companies higher public-relations firms to distribute dubious claims as to the fantastic success the product the penny stock company is selling in an effort to pump the price higher than might be expected. This make sense because oftentimes these public-relations firms are paid in stock from the firm and it is in their best interest to inflate the stock price to increase their profits. This technique is often referred to as “pump and dump.” Penny stock investing is rife with firms engaged in pump and dump activities, so any information received from third-party sources promoting penny stocks should be taken with a grain of salt as its accuracy can be dubious, at best.

My recommendation is to avoid penny stocks, no matter how enticing they may appear. All that glitters is not gold, and penny stocks are certainly no exception to this rule.