Value stock market investors are piling into low-priced stocks at a record rate, particularly so-called “penny stocks.” While there is no strict definition of the term, it is often used to refer to any stock trading below $5 per share, although many penny stocks actually do trade for just a few cents per share. The majority of these penny stocks trade on the “OTC Markets” rather than on major exchanges like the New York Stock Exchange or NASDAQ. Stocks traded on the OTC Markets are subject to less stringent listing requirements than stocks traded on the major exchanges.
Some investors justify purchasing low-priced stocks by saying, “You can’t lose much on a low-priced stock.” While that may be technically true on a dollar per share basis, you can lose just as much of your total investment on a stock trading at 1 as you can on a stock trading at 50–in either case you can lose up to 100% of your investment.
It should be noted that The Turnaround Letter rarely recommends stocks listed on the OTC Bulletin Board or Pink Sheets because their liquidity is insufficient; however, there are are exceptions. For example, The Turnaround Letter recently offered up this promising large-cap whose shares trades OTC--at 19.9x earnings and only 7.7x cash flow. In this case, the value stock pick's future looks much brighter than its past troubles imply: The company has many valuable assets, and its solid balance sheet provides financial flexibility.
The above example illustrates that despite our valid and necessary warnings, it is certainly possible for distressed investors to make substantial profits on low-priced stocks--particularly if the stock price is low because the company is in the process of turning around. Turnaround companies usually have substantial operating histories and significant assets, but their stock prices are low because recent results have disappointed investors. The key here is a prudent distressed investing strategy focused on deeply-diversified long-term holdings and value stock opportunities with a primary focus on well-known companies with a solid core business, established track record and good brand name or franchise around which to build.
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