Small-cap investing can be difficult sometimes. Wall Street shuns it, mainstream media ignore it, and most investors are scared of it. Why is this?

First of all, everyone has heard the stories about someone losing of all his or her money through those "risky penny stocks." But everyone has also read the stories about someone striking it rich with just one tiny investment in those "lucrative penny stocks." Frankly, both stories are true. But one is actually truer than the other…

The Risks and Rewards of Penny Stocks

To simply shun penny stocks - as many on Wall Street do - is a mistake. I can give you one simple stat to prove it.

In a famous Tweedy, Browne report back in 1983, every publicly traded U.S. stock was grouped by size. As you can see below, the smallest groups fared the best…

Tiny Stocks Beat up on Their Large Counterparts

source: Tweedy, Browne’s What Has Worked in Investing

As the size of the companies in each group gets larger, the returns are smaller. Obviously, those who invested in small companies over the period of 1963-1980 did quite well. You could say small caps offer a higher reward than their larger counterparts. But that doesn’t say anything about the risk.

You see, without understanding the risks, blindly investing in penny stocks is dangerous. You can’t expect every 10 cent stock to jump to $10. Occasionally, companies run out of money or the patent becomes obsolete. There are a billion reasons for penny stocks to fall apart, but for every one of those, there are 10 reasons for buying.

Sure, if you buy three, you might have one go bankrupt and one that doesn’t move in price, but one could shoot up a few thousand percent. That’s the real risk-to-reward we look for when dealing with penny stocks. We’ve seen tons of our picks shoot from just a few cents into the $10-20 range. Believe me - it’s worth it when that happens…

Sincerely,

Jim Nelson