Penny Stocks and Arbitrage

Q Why wouldn’t penny stocks make me rich quickly, when I can buy thousands of them for a few hundred dollars? — B.Y., Hickory, North Carolina A Penny stocks are not just stocks with extra-low prices. Trading for $5 or less per share, they can be more likely to plummet than skyrocket. They’re risky, and often hyped and manipulated. While penny stocks may seem like bargains, they won’t necessarily grow faster than other stocks. A $1 stock and a $40 one can both go up (or down!) by the same percentage in one day. With a 5-percent increase, the $1 stock will rise in value by 5 cents, to $1.05. For the $40 stock, it’s a $2 jump, to $42. The $40 stock is likely tied to a healthier company, perhaps with competitive advantages, actual revenue and profits, and a more attractive valuation. If so, it’s a far better bargain than the $1 stock. Penny-stock investors are often naive beginners looking to get rich quick, but that’s not how reliable wealth-building works. Focus on the long run: Plenty of big, successful blue-chip companies have rewarded shareholders handsomely over many years, while penny stocks have wiped out many investors. *** Q What’s arbitrage? — R.W., online A It’s when you profit from temporary price differences. For example, perhaps MacDonald Farms Inc. (ticker: EIEIO) is trading at $55 per share on a U.S. stock market and at $55.10 per share on a foreign market. If you simultaneously buy some of the lower-priced shares and sell the same number of higher-priced shares, you’ll reap a profit of 10 cents per share (not counting commission costs). This may seem negligible, but arbitrageurs often invest very large sums.