Is it safer to gamble on the lottery…or on penny stocks? That depends on whom you ask, and the economic climate. Right now, there are an awful lot of great companies that have dipped into penny stock range. There are also a lot of great companies that have always traded as penny stocks.
With so many great companies trading under $5, there are a lot of seasoned investors paying close attention to penny stocks. But will their focus pay off? Or are they just wasting their time. Are they better off playing the lottery? If they don’t do their research they are.
A recent study out of the University of Texas at Austin suggests that investors who gamble in the stock market have the same characteristics as lottery players.
The socioeconomic characteristics of people who play state lotteries (odds of winning are about 18 million to 1) are similar to investors who pick lottery type stocks; high risk with a small potential for large returns. And, just like the lottery, returns are lower for those who invest this way in the stock market.
Alok Kumar, assistant professor of finance at the McCombs School of Business at the University of Texas at Austin presented his evidence of after studying the demographics and financial transactions of 70,000 anonymous investors.
Kumar defines lottery-type stocks as those with a share price under $5 and a history of high volatility and extreme positive returns. These stocks are (relatively) inexpensive and come with a high chance of losing. At the same time, they also offer the potential for a big return.
Yup, that sounds like the definition of a seedy penny stock.
Kumar's research found that people with household income below average for their area are more likely to buy lottery-type stocks, and that they are purchased in areas with high unemployment and during economic downturns.
Interestingly, in addition, regions with higher concentrations of Catholics such as in Massachusetts and Rhode Island have a stronger preference for lottery-type stocks, while those in Protestant regions like areas in the South are less drawn to them—a pattern that also mirrors ticket purchasing trends in state lotteries by the two groups.
“It is particularly important to be aware of our gambling tendencies now because the urge to gamble is greater during difficult economic times,” Kumar said. While not to minimize the losses associated with lottery-type penny stocks, it’s important to also see what Kumar’s research uncovered.
“We found that people who took risks with lottery-type stocks typically earned 2% to 3% less than other investors,” he said.
I’m not so sure that’s the kind of statistic though that’s going to act as a deterrent to those delving into risky penny stocks. If you could guarantee investors would only lose 3% on a crappy penny stock I think they’d be more than willing to take that risk.
Still, not all stocks trading under $5 are lottery-style penny stocks; just most of them. Fortunately, finding an excellent penny stock is a little easier than the art of divining winning lottery tickets.
And frankly, whether you’re looking at a penny stock or large-cap stock, the same criteria are important. Some Wall Street Philistines may tell you that trading penny stocks is a sure-fire disaster. At the same time, the wizards of Wall Street really don’t have much Street cred these days.
In a nutshell, forget the stock price and pay attention to the company at hand. Invest in a company whose operations you understand. Look at their prospects, management, valuation, cash and debt level.
In this current economic climate, are they tightening their belts or streamlining operations for the market’s eventual recovery? Or, has the market opened up new opportunities that otherwise might not have been there?
While it’s always interesting to point out a penny stock company poised for growth once the economy turns, it’s equally as enjoyable to talk about one bucking the trend. ClickSoftware Technologies (NASDAQ: CKSW, Stock Forum) is one company whose share price has been on a tear over the last four weeks.
On February 4, CKSW announced that fourth-quarter revenue climbed 35% year-over-year to $14.1 million. Fourth-quarter net income came in at $5 million, or 17 cents per share, a significant improvement over the $0.5 million, or two cents per share, recorded in the same period last year. Total revenue for 2008 grew 31% year-over-year; consolidated net income soared 211% to $8.1 million, or 28 cents per share.
“The results for 2008 show significant improvement in just about every aspect of the business: revenue growth, profitability, margins, and EPS.” said Dr. Moshe BenBassat, CEO and chairman. “These results for 2008 are particularly pleasing considering the global economy recession.”
In February alone, CKSW was awarded a large contract from an existing customer and signed a contract with one of the U.K.'s largest energy companies. CKSW also announced an agreement with Ireland's largest energy company. Finding good penny stocks shouldn't be a gamble. And for those willing to do the research, it should pay off.
Read more Stockhouse articles by John Whitefoot
