But now
you're risking thousands of dollars. Very risky.
Cheap stocks can be easily manipulated by someone
talking them up in an internet chat-room. Called "pump
and dump", it does happen. A stock that trades maybe
5,000 shares a day is easy pickings for these scammers.
You can be tempted into buying at an artificially high
price, then watch it drop 50% in just a couple of days.
You also pay a higher spread to buy into a thinly traded
company.
Historically, small-cap stocks, as a percentage of
return on your investment, have outperformed large-cap
stocks; not because a bunch of cheap, small companies
are a better investment than big companies, but because
almost all big companies were small when they first sold
stock. But many (maybe most) large companies are all
through growing and are just fighting for market share,
such as Coca-Cola and General Motors.
Never, ever buy a low-priced stock just because it
used to trade at a much higher price, hoping it will
return to its glory days. You have to ask "why
did the price fall so low in the first place?"
The market has thousands (yes, thousands) of
disappointing companies whose stocks are not only
trading below $10, but are headed lower. Relatively few
of these stocks are heading back up.
A Merrill Lynch study looked at 1,900 stocks that had
fallen below $10 a share from 1987 to 2000. On average
only 1 out of 30 rebounded to over $15 during the next
year after dropping under $10.
Year |
|
Number of stocks that
fell below $10 |
|
Number rebounding
to over $15 |
___________________________________________________ |
1987 |
|
63 |
|
|
3 |
|
1988 |
|
69 |
|
|
1 |
|
1989 |
|
33 |
|
|
0 |
|
1990 |
|
52 |
|
|
0 |
|
1991 |
|
46 |
|
|
4 |
|
1992 |
|
52 |
|
|
1 |
|
1993 |
|
83 |
|
|
0 |
|
1994 |
|
99 |
|
|
3 |
|
1995 |
|
92 |
|
|
3 |
|
1996 |
|
208 |
|
|
10 |
|
1997 |
|
286 |
|
|
4 |
|
1998 |
|
371 |
|
|
20 |
|
1999 |
|
265 |
|
|
30 |
(buying
mania) |
2000 |
|
437 |
|
|
5 |
|
Avoid any stock that has fallen to under $10. Sure, it
may recover someday. But why tie up your money in a
company that may go nowhere for years. Wait until the
company has proven itself and then pick the sensible
point to buy.
There are many gems among the small-cap companies if you
can spot the true up-and-comers.
Just because a company is small, and maybe its stock is
priced low, doesn’t mean it should automatically be
passed over. There are some young, quality companies,
whose stock is trading for under $5 a share. It’s the
stocks that have crashed from lofty heights that you
should avoid like the plague.
I would like to emphasize that you can not tell if a
company is a small-cap or a large-cap by its share
price. Market cap is the share price times the
number-of-shares available for trading. There are many
quality small-cap stocks trading for over $20 a share.
The next section, Financial Statements, is quite
important. Our examples will throw around the words
“billions of dollars” maybe a bit too casually.
It is hard to comprehend just how much a billion
dollars is, let alone billions and billions.
If you were to leave home and spend $1,000 a day, not
returning until you’ve spent a million dollars, you
would come back home in about 3 years. If you had a
billion dollars to spend at the same rate of $1,000 a
day, you wouldn’t return for 3,000 years. JDS Uniphase’s
$44 billion write-off, for example, would take over
120,000 years. |
Other Stock Market Basics Topics:
-
Stock Market Investing – the Right Way
-
More Stock Marketing Investing
-
How to Pick Winning Stocks
- The Golden Rule of Investing
- Avoid Psychological Traps to Have Successful
Investing
- Changes in Stock Values Can Be Big Numbers
- How to Invest Smart
- Stock Advice - Important Selling Rules
- Poor Stock Buying Decisions
-
Market Indicators
-
Stock Market Cycles
-
When a bear stock market may not
be a bear market
-
Stock Index Futures
-
Four Things
that Affect Stock Valuation
-
What is a P/E ratio?
-
Value Investing
-
Cheap Stocks
-
What is a Financial
Statement?
-
Analyzing Financial Statements
-
Stock
Market Tip - Red Flags to Look For When Investing?
-
The Annual Report – How to Read
-
Stock Market
Analysts – Stock Market Advice and Tips
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