Back in the 1940s, it would have been nearly impossible to find a true penny stock. That all changed in 1971, with the creation of the National Association of Securities Dealers Automated Quotation system (NASDAQ). This is now the home of thousands of penny stocks.

You see, the idea of entrepreneurialism has been around since the start of human history. But until 1971, it was nearly impossible to invest in startup companies.

The NASDAQ was created to do two things: First, it gives public companies an alternative to the New York Stock Exchange, or the "Big Board." But it also gives small companies a chance to build capital, which is how they can eventually grow into "Big Board" stocks. Let me explain…

Why do companies let investors decide their values? In other words, why do companies go public in the first place?

The answer is, of course, money…Public companies have the unique ability - and advantage over private companies - to raise capital by simply selling more shares. This is very common in the penny stock world. That’s the real reason any company initially goes public.

Building capital is fundamental in early growth projects. For instance, say you run a small software development company. You realize that you need to expand your manufacturing facilities, but you have no more money in the bank. You have to do one of two things: Try to secure a loan or just sell more shares. Loans, of course, need to be paid back. But selling more shares has its own problems…

There are two ways to go about selling shares:

Many companies sell shares in a private placement. That means just that a large bank or investment house wants to invest in the company, but doesn’t want to deal with the fluctuations that occur on the open market. So it pays a lump sum and receives shares of the company. It’s that simple.

The other way a company can sell shares is by putting them out on the open market. So whatever price investors are trading the company’s shares for currently is the price for which the new shares are sold.

Of course, both ways dilute the value of the shares. But that’s all part of the game. Smart investors invest only in companies capable of growth. So to grow, these small companies have to raise capital.

Most of the time that this happens, the share price doesn’t even move. Shareholders expect that from time to time.

So the question remains…why would anyone invest in penny stocks if they knew the company would probably dilute the shares’ value?

Whether or not a company is diluting its shares, the only thing that matters is share price appreciation. It’s very difficult for a $50 stock to become a $100 one. But to go from $2 to $4 is relatively easy.

That’s why the NASDAQ has been so successful. Companies can create capital easily, and investors can double their money with just a small jump in share price. It’s a win-win situation.

Sincerely,

Jim Nelson