How to make big money from penny stocks

Penny stocks are very popular with investors, especially when markets are down. I think there’s cash to be made, but extra care is needed.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Close-up of British bank notes

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

When stock markets are weak, a lot of investors see a chance to make some cash from penny stocks. And I’m one of them, but cautious too.

In the past 12 months, the FTSE 100 has been flat over all. So the 2023 drop so far is really just the reverse of those late-2022 gains.

But look at the FTSE Small Cap index. Over the same 12 months, it lost 13%. Lucky for some? Maybe.

The AIM index, home to many very small growth stocks, has dropped by a huge 24% in the same period.

Risk and reward

So there’s more risk of losing money with small-cap stocks, including penny stocks, than with big blue-chip ones. But I’m sure most people accept that.

But the converse has to be true. If they tend to fall more in hard times, they’ll surely gain more in good times, right?

It doesn’t matter whether the value is £10bn, or less than £100m. If a company looked good last week, and its share price falls this week with no bad news, it must be better value now, surely.

Long term

Looking at the charts again, this time over 10 years, is telling. The FTSE 100 has managed a 16% rise in a decade. But the small-cap index is up 58%.

The AIM index is curious. Over 10 years it’s only made 9%, but it’s had much bigger peaks from time to time. By April 2021, for example, AIM stocks were well ahead, up 75% compared to the Footsie’s 9%.

So looking for penny stocks to buy when they’re down clearly can be a money-making strategy. But I do think it needs a lot more care, in a few key areas.

Resilience

Rolls-Royce suffered in the Covid crash. That’s a huge FTSE 100 company, and it had the clout to raise the cash it needed to survive. It now looks to me to be set to thrive.

But a tiny company can find it a whole lot harder to raise cash when times are tough. Some of the worst I’ve seen have had to rely on issuing more shares, year after year after year.

I won’t name my worst example, but it’s issued massive quantities of new shares, and pushed the price down to a fraction of a penny. Those who bought at flotation have lost 99.99%.

Wipeout?

So, yes, a very small company faces more risk of going bust in a bear market. Or, at least, diluting its shareholders to near zero.

Even without a slump, debt doesn’t sit well with penny stocks for me. And I also don’t like ‘jam tomorrow’ ones with no profits yet. I avoid those, unless I see plausible profit forecasts.

So, for me it comes down to one key thing. And that’s to be far more critical of the financial state of a small company than a large one.

That’s why I buy very few penny stocks. But when I see one that I think is super cheap, I’m in.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Asian man looking concerned while studying paperwork at his desk in an office
Investing Articles

After gaining 34% in a month, is the Nvidia share price now uninvestable?

Our author says the Nvidia share price is very high at the moment. He's cautious when considering investing in the…

Read more »

Businessman use electronic pen writing rising colorful graph from 2023 to 2024 year of business planning and stock investment growth concept.
Investing Articles

This under-the-radar FTSE 100 share has hiked dividends 13.7% a year for a decade. Time to buy?

Harvey Jones is kicking himself for missing out on this FTSE 100 share that's kept investors happy with long-term share…

Read more »

British union jack flag and Parliament house at city of Westminster in the background
Investing Articles

Labour winning the general election would be positive for UK stocks, says JP Morgan

One mega-bank thinks certain UK stocks could benefit following the 4 July election. This writer considers a FTSE share that…

Read more »

Older couple walking in park
Investing Articles

No savings at 40? Here’s how I’d aim to retire comfortably with FTSE 100 stocks

It's never too late to begin investing in FTSE 100 stocks for retirement. Royston Wild reveals three steps to help…

Read more »

Young Asian man drinking coffee at home and looking at his phone
Investing Articles

Down 17%, is National Grid’s share price a FTSE 100 bargain?

National Grid's share price has taken a battering following a multi-billion-pound rights issue and dividend rebasement. Is it now too…

Read more »

Environmental technology concept
Investing Articles

Up 150% this year! Can NVIDIA stock keep on soaring?

Christopher Ruane explains why NVIDIA stock has soared over 150% already this year, where it might be going -- and…

Read more »

Investing Articles

Down 44% in a year, here’s why the Aston Martin share price could keep struggling

Not only has the Aston Martin share price collapsed in recent years, our writer sees its current business performance as…

Read more »

Investing Articles

I’m considering these 2 high-growth stocks to buy as a technology investor

Our author thinks Kainos and Softcat could be two of Britain's best tech investments. He thinks the risks in the…

Read more »