Market Buzz – Penny Stocks – Two Common Fallacies

Posted by Ryan Irvine - Keystone Financial

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Market BuzzSlowing Growth Trend Continues, North and South

While the S&P/TSX Composite Index closed Friday down 15.21 points to 11,713.43, it ended the month 3.7% high, continuing its recovery from the relative carnage we saw in May.

Having said this, going forward, investors will have to weigh the underwhelming growth readings released today for both Canadian and U.S. economies. Statistics Canada said the country’s gross domestic product grew by 0.1% in May, better than the flat reading in April but slower than experienced in the first quarter.

In the U.S., the Commerce Department reported that the GDP grew at an annual pace of 2.4% from April to June. The number was less than the 2.5% that economists had expected.

Immediately following their releases a number of commentators indicated the twin reports suggest that Canada is maintaining a slow-but-steady recovery from the recession while the U.S. is waging a tougher battle to regain ground. For us however, the overarching theme was one the North American economy’s abrupt Q2 2010 slowdown from the first quarter’s strong growth.

The Canadian economy’s tepid growth of 0.1% seen in May, while up from a flat reading in May, is a far cry from the spectacular growth spurt that began last fall and continued into this year, when the economy grew 4.9% in the last quarter of 2009 and a decade best 6.1% in the first quarter of 2010.

While the May pace is not disastrous, it will make it difficult for the economy to match the Bank of Canada’s recent projection of 3% growth in the second quarter, which ended June 30.

Switching gears to our Canadian Small-Cap Universe ( we take a quick look at a long-time favourite of ours, Glentel Inc. (GLN:TSX), a leading provider of innovative and reliable telecommunications services and solutions in Canada and the United States. Glentel has grown to become the largest multi-carrier mobile phone retailer in Canada operating more than 280 locations.

This past week the company reported that its sales for the three months ended June 30, 2010 grew 16%, to $78.97 million from $67.85 million in the same period of 2009. Net income and basic earnings per share for the three months were $3.76 million or $0.34 per share respectively, compared to $2.64 million or $0.24 per share, for the same period in 2009.

We are happy to report the stock surged just under 10% on the news and hit a new all time high this past week.

LooniversityPenny Stocks – Two Common Fallacies

Two common fallacies pertaining to penny stocks are that many of today’s stocks were once penny stocks and that there is a positive correlation between the number of stocks a person owns and his or her returns.

Investors who have fallen into the trap of the first fallacy believe Wal-Mart, Microsoft, and many other large companies were once penny stocks that have appreciated to high dollar values.  Many investors make this mistake because they are looking at the “adjusted stock price,” which takes into account all stock splits.  By taking a look at both Microsoft and Wal-Mart, you can see that the respective prices on their first days of trading were $28 and $25 even though the prices adjusted for splits is $0.09722 and $0.02444.  Rather than starting at a low market price, these companies actually started pretty high, continually rising until they needed to be split.

The second reason that many investors may be attracted to penny stocks is the conception that there is more room for appreciation and more opportunity to own more stock.  If a stock is at $0.10 and rises by $0.05, you will have made a 50% return.  Couple this with the fact that a $1000 investment can buy 10,000 shares convinces investors that micro-cap stocks are a rapid surefire way to increase profits.  Truth be told, without independent research from a company like say KeyStone Financial ( which happens to specialize in the small- and micro-cap markets, many investors end up with pennies on the dollar from investing in so-called “penny stocks.”

Put it to Us?

Q. Can you give me a quick overview of “contrarian” investing or the contrarian style of investing?

– Gabriel Wilson; Calgary, Alberta

A. Ah, the contrarian – you say black, he says white; up – down; bad – good; you get the picture.  A contrarian investor is generally an individual that invests against market trends and does not follow the prevailing consensus view.  Yes, a true rebel, maverick, or rogue of the intriguing world of investing – yeah, right!

Generally, a contrarian investor believes that the people who say the market is going up do so only when they are fully invested and have no further purchasing power.  At this point, the market is at a peak.  On the other hand, when people predict a downturn, they have already sold out, at which point the market can only go up.

The contrarian generally focuses on turnaround situations and stocks currently out of favour with low P/E ratios, practicing patience and long-term investing.

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