Investing in smaller companies

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8. Penny shares and other speculative stocks

Penny shares, meaning companies whose share prices are below about £1, are not necessarily companies with small market caps, but often they are. They are worth mentioning briefly in this tutorial because:

• investors often mistakenly equate penny shares with small caps
• investors often mistakenly assume that because a share price is low, the shares are cheap
• penny shares are often presented as high growth companies and treated by investors on that basis
• penny shares are volatile

Richard Koch, author of Selecting Shares that Perform, says:

Not a fan then.

In a rampant bull market, penny shares can be seductive, with prices doubling or tripling in days if a share is tipped in the newspapers. The hope of the investor is that the go-nowhere company will be pounced upon by a stock market buccaneer who uses it as a shell to start a completely new and proper business.

Wishful thinking? In most cases, yes. But it does occasionally happen. WPP, the world's largest advertising company, was a lowly manufacturer of wire supermarket trolleys until Martin Sorrell reversed into it and set it on its stellar growth path. WPP notwithstanding, penny shares rarely have the fundamentals to justify serious investment. They can be risky punts.

In the same bag are investments in mineral and oil exploration companies, and companies trying to find the latest biotech health cure. No one apart from the directors of these companies has a clue whether they will make money, and often they don't know either. The only rational approach, if you are attracted to them, is to consider spreading your investment.

1. What is a small cap? 2. The arguments in favour of smaller companies 3. The arguments against smaller companies 4. The aim of investing in smaller companies 5. No single method 6. Is it a good business? 7. Can you buy at a reasonable price? 8. Penny shares and other speculative stocks 9. A note about tax 10. Other tips 11. Conclusion

• Investor's Guide To Selecting Shares that Perform