Types Of Penny Shares

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Types Of Penny Shares

A share will generally fall into the category of penny share because it is a company with a low total value of assets (known as a small market capitalisation).

It is worth pointing out that a 'small market value' is relative! When compared to many 'small' businesses, penny shares are very large companies. However, when compared to the really big firms (firms like Exxon, Goldman Sachs, Tesco, Google, Texaco) with valuations in the tens of billions, penny shares really are tiny.

These companies are usually tracked by their own index (for example, the FTSE Fledgling in the UK) and are often referred to as 'Small Cap' (Cap referring to capitalisation).

Often, not always, but often, these types of companies are quite tightly controlled by one (or a small number - often a family) of shareholders. Clearly, any one family that owned most of a super global player such as HSBC would be phenomenally wealthy, and there are some firms like that, but most global titans have millions of individual owners.

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Smaller companies, however, are much more likely to still have a major shareholder that was perhaps the founder or one of the founders. These individuals will own a significant portion of the company, meaning that the smaller investor is rather at the mercy of his or her whims. This might mean that things like a management buy-back are more likely than with other companies.

Some countries operate separate stock markets for small and fast growing companies. A great example is the Alternative Investment Market that is linked to the London Stock Exchange as a 'sub market'. AIM accepts companies with shorter trading histories and requires a lower standard of accountancy, auditing and oversight. Needless to say, this makes these investments much higher risk than many other elements of stock market investment.

This article from October 2007 about the UK AIM market offers excellent descriptions of some of the risks that can await an investor in these smaller and less regulated markets. Many beginner investors choose smaller markets to get started but this is often a poor strategic decision. They are taking additional risks that they probably do not fully understand. It is rarely the case that an illiquid smaller company would be the right choice for an investment beginner.

It is worth noting that whether an investor buys 10 shares for $100 each at a total cost of $1,000 or 4,000 shares at 25 cents each, the total risk to the investor is still the same total amount of money. And while it may seem that a smaller move in price will have a bigger impact on returns for the 4,000 shares, the likelyhood of such a small company failing completely is often much higher than with the bigger firm.

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These smaller markets often contain a number of companies that could best be described as a complete gamble! Such companies (small internet start ups, biotech firms, mining companies testing land for natural resources and many more) often provide an unknown 50-50 gamble. If the firm finds oil/gas/gold/a cure to a disease etc etc, their future looks good and money will be made. However, the companies that do not 'make it' of which there are many, will often limp along, gradually draining their cash reserves as they continue their search or product development.

The rate at which they spend money is known as their cash burn rate and is used to provide investors with an insight as to how long they can last without further financing. Needless to say, companies without a product, that are running out of money, represent a high-risk investment and are probably not for beginners!