Penny stocks are a popular option for potential high-growth, risk-seeking investors. This class of stocks provides the greatest potential upside for individuals comfortable taking on substantial risk.
But is the risk-reward balance worth it? And can investors actually get rich by investing in such companies? Let’s explore.
What are penny stocks?
Penny stocks is a term used to describe shares of a publicly listed company that is very small. While some variations exist, a business is typically placed into the “penny” category if they have a low share price of less than £1 and the total market capitalisation is less than £100m.
Due to their small size, these companies are often financially weak, with limited resources, and have unproven business models. This makes them highly susceptible to insolvency, especially during times of economic turmoil. It’s also the reason why penny stocks are notoriously volatile and risky.
In fact, a 2012 study investigated the performance of penny stocks in the US between 2001 and 2010. The results showed that, on average, penny stocks delivered a -60.54% annual return to investors, with share prices being roughly 2.9 times more volatile than companies listed on the Nasdaq exchange.1
Despite the high risk associated with penny shares, they remain incredibly popular among investors with a high-risk tolerance. Why?
For short-term traders, the stock price volatility creates opportunities to profit from large swings in valuation. But for long-term investors, if a penny stock can beat the odds and achieve success, the potential gains can be ginormous.
Popular UK penny stocks
Penny stocks tend to fall in and out of fashion incredibly quickly, but some do retain interest longer than others. However, it’s worth mentioning that popular penny stocks are not necessarily the best penny stocks to buy.
| Penny Stock | Industry | Description |
| Woodbois Ltd (LSE:WBI) | Raw Materials | A sustainable supplier of hardwoods and softwoods used by the construction sector |
| Argo Blockchain (LSE:ARB) | Technology | A cryptocurrency mining firm |
Woodbois Ltd
Woodbois owns and operates a collection of sawmills and veneer factories based in Africa. It plays a critical role in the supply of hardwoods and softwoods to the region as well as the general global markets.
Today the company has a material portfolio that spans over 23 hectares of forest. However, the firm’s unique operating procedures put a lot of emphasis on sourcing materials sustainably through reforestation. Despite its small size, the group is currently the eighth-most sustainable timber supplier worldwide.
Further instability could harm the company’s ability to generate consistent, positive cash flows.
Argo Blockchain
Argo Blockchain is a cryptocurrency mining firm that specialises in Bitcoin. The group owns and operates many mining farms in the US that use sustainably sourced energy to mine digital tokens.
With most of its assets held in Bitcoin, any collapse of the cryptocurrency price can lead to similar volatility in the Argo Blockchain share price. This highlights the highly cyclical nature of the business.
How to buy penny stocks in the UK
Penny stocks are bought and sold just like any other publicly traded company. However, due to their small size, these businesses are typically listed on the London Stock Exchange’s Alternative Investment Market (AIM). However, there are some exceptions.
Shares listed on AIM are subject to less strict financial regulations when it comes to reporting information to shareholders. And this can make analysing such businesses trickier due to the reduced level of insight.
Most British investment accounts allow investors to access AIM to buy and sell shares as they do with the main market. This includes special tax-efficient accounts like the Stocks and Shares ISA and Self-Invested Personal Pension (SIPP). However, there are some exceptions.
Due to the higher-risk nature of this stock market segment, not all brokerages provide this access. Therefore, an investor seeking to buy shares in a penny stock listed on AIM must open an investing account with a broker or gain access to a trading platform that allows this.
How is penny stock trading taxed in the UK?
Please note that tax treatment depends on the individual circumstances of each individual and may be subject to future change. The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
The taxation process for penny stocks is very similar to any other form of equity investment. Therefore, the tax protection status offered by a Stocks and Shares ISA still applies.
If a regular investment account is being used, then capital gains and dividend taxes from penny stocks are calculated as normal. However, the key difference is the treatment of stamp duty.
Under normal circumstances, an investor purchasing shares in a UK-listed company must pay stamp duty reserve tax. This is equivalent to 0.5% of the total transaction amount. For example, investing £1,000 would result in a £5 fee.
However, shares listed on the AIM are not subject to this tax. And therefore, when purchasing penny stocks listed on AIM, there is no stamp duty to be paid.
Can you get rich trading penny stocks?
Buying shares in a successful business while it’s still in its early stages is an enriching process. It’s not uncommon for investors to enjoy triple- or even quadruple-digit returns over the long run should a small enterprise eventually become an industry leader.
The possibility of ginormous returns is why penny stocks are so popular. But with massive rewards come massive risks.
As previously stated, the stock market’s average return of penny shares is pretty abysmal. The vast majority end up failing to deliver on expectations, leaving many excited investors with little or nothing left of their original investment.
Therefore, penny stock trading for the short term or investing in the long term can be a successful path to becoming rich. However, the odds of succeeding are exceptionally slim.
Do penny stocks go to zero?
As previously mentioned, the weak financial position most penny stocks find themselves in makes them highly volatile investments.
In many cases, the valuation of a business operating in this segment of the stock market is driven by mood and momentum. If investors are feeling optimistic, a penny stock can start climbing significantly just based on expectations of future returns. However, the opposite is also true. When valuations are driven by expectations rather than fundamentals, the slightest hiccup can open the door to a lot of volatility.
This is most commonly seen with young mining exploration or biotech businesses. If successful, these companies can tap into enormous revenue streams and market opportunities. However, evolving from a research-based operation to a production-based one is never straightforward, and there is a high probability of failure along the way.
A mining feasibility study or early clinical trial result that doesn’t provide positive news can cause all excitement surrounding a business to evaporate, wiping out the share price in the process. And in some cases, if developments end up compromising the long-term potential of a penny stock, it can collapse to zero, leaving investors with nothing.
Are penny stocks worth it?
Penny stocks are not for everyone. Investing early in a business is already incredibly risky by itself. However, things only get more intense when volatility enters the picture and makes investors constantly question their decisions.
Yet, in exchange for all this risk, investors are granted the opportunity to snap up shares in a business that could explode over the long run. And there are quite a few stories where a small early investment can skyrocket into a mountain of wealth. Those who invested in Apple or Microsoft back in the 1990s know this all too well.
Deciding whether or not penny stocks are worthwhile ultimately depends on the individual and their circumstances. Investors who have a low tolerance for risk likely won’t find penny stocks enjoyable or suitable for their portfolios. Yet growth-focused investors with a stomach for volatility may find them to be an exciting opportunity to explore as part of their portfolio.
Alternatives to investing in penny stocks
While penny stocks can bring a lot of excitement to the investing process, their high-risk profile makes them unsuitable for many individuals. Fortunately, there are alternative options for high-reward-seeking investors,
Small-cap stocks share a lot of characteristics with penny stocks. After all, these businesses are still young, offering plenty of upside potential. However, small caps also often have a more established financial and operational position. So, while they are still a risky investment class, the probability of failure is significantly lower than that of penny stocks.
The leading small-cap index in the United Kingdom is the FTSE AIM 100. And between 2016 and 2021, the index delivered an average annual return of 9.4%2. That’s significantly higher than the past performance of penny stocks and is firmly ahead of the average returns offered by larger UK stocks listed in the FTSE 100 over the same period.