A Comment -- General Comments From an Expert (A Commentary)

The Risks of Penny Stocks 101: Costs of Being Public

Would you buy an exchange-traded fund with a nine per cent expense ratio? Of course not. But a tiny company listed on an exchange has very high expenses just to maintain being public. There are listing fees as well as lawyers, accountants and regulators to pay.

The cost of being public can vary with the exchange, but can typically run to $300,000 or more annually. Yet, there are hundreds and hundreds of penny stock companies out there with market capitalizations of $2 million to $4 million. A $3-million company, then, might be paying 10 per cent of its entire market cap just to be public. This expense will impact the company every single year, regardless of its success or lack thereof.

Typically, ongoing expenses and losses result in continuous share issuance and dilution at tiny companies. This expense drag is a huge impediment to investment performance and shareholders suffer as a result.

But the next time you find yourself tempted, take a look at the reality and risk of what you are considering buying. With even five minutes of research, you might realize you are not buying quality.
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The current record-breaking rally reminds him of the dotcom bubble of the late-1990s and usually these periods don't end too well. These prices reflect a gambling, rather than an investing, mindset. He looks at the cyclically adjusted PE on a 10-year basis which is now quite high. Canadian looks pretty well priced vs. the US; perhaps there's some safety in that. This rally will drive people more towards value stocks. Stocks with high multiples that have run up have the furthest to fall. Be more defensive now, so you won't be hurt too badly when the market falls. He doesn't think the US wants to tariff themselves into inflation, but they want a different trade deal with Canada and Mexico.

A new member of the Fed wants aggressive cuts, compared to his peers. If inflation was more contained, the Fed could get more aggressive. The worst thing would be the Fed cutting rates, then raising them again later. This new member is looking at the next few years, not quarters. For example, if immigration continues to be limited, then rent inflation will be curtailed. So, demographics support the notion of inflation will come down. Larry argues that less globalization would be an equal and opposite force that would push inflation up.

There's money on the sidelines, but he doesn't know. Probably, people are reluctant to sell because share prices keep going up. Probably, selling will happen when there's bad earnings news. Maybe the markets keep grinding higher, helped by declining interest rates.

Gold was a dog for a while and people got into crypto, and now gold is back. It's going up, but not as an inflation hedge. Gold is very overbought and he wouldn't buy it now. He would not buy this current breakout.

Last week, we saw an update of projections from the U.S. Fed. Core PCI is what they focus on, and the Fed is concerned that inflation will remain elevated above their 2% target for the next year or so, though they feel that inflation will reach 2% eventually in 2028. Good sector inflation was flat since 2001 till Covid, even deflationary. With Covid, it spiked before declining. Service sector inflation has long been higher than goods and also spiked during Covid and also declined. Both inflations are now climbing and will continue for 6-12 months. He is certain of this given tariffs and slower globalization. The worst thing is for the Fed to cut interest rates aggressively only to reverse this later. Also, 72% of CPI components are rising faster than the 2% inflation target. A real weakening in labour will lead to serious interest rate cuts, though. History shows inflation will rise: the inflation spike of the 1970s from the oil crisis, then the spike in the late-1970s and early 1980s. All this will mean the Fed will keep rates higher for longer. But will this inflation slow the economy? Most participants in the market don't care. Is gold hitting new highs because of inflationary worries?

The Risks of Penny Stocks 101: Susceptibility to Manipulation and Fraud

The combination of tight floats, low liquidity and low regulation makes penny stocks especially prone to market manipulation such as pump-and-dump schemes. Corrupt management and promoters can artificially drive up prices, attract unsuspecting investors and rapidly sell out, causing prices to collapse and major losses for those left holding shares.

Don’t believe us? There was once a company that at one point was worth $10 billion. Its business? Searching for Bigfoot. We can’t make this stuff up. Or, more recently, seven Nasdaq-listed micro-cap stocks — Concorde International Group Ltd., Ostin Technology Group Co. Ltd., Top KingWin Ltd., Skyline Builders Corp., Everbright Digital Holding Ltd., Park Ha Biological Technology Co. Ltd. and Pheton Holdings Ltd. — all dropped more than 80 per cent in a matter of weeks in July after first being pumped up and heavily promoted on social media sites.
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If Canada and the US continue to cut interest rates this is a time honoured formula to help the economy. It is easier for businesses to borrow and raise capital so money goes almost entirely into the stock market. Even if the economy doesn't do anything, even if unemployment continues to rise, even if trade relationships deteriorate, lower interest rates will boost markets. If people think we're in a bubble, he doesn't think they've seen anything yet. He continues to like the tech sector where cheap money is available. With lower interest rates he also likes the property re-financing sector in the US as well as life insurance and insurance companies in general.

The question was on his opinion of the banking sector. The Canadian banking sector is the most effective lobby group in the country and should continue to do well. His favourite is Royal Bank which seems to set the agenda.

Absolutely. Investors have a lot of money on the sidelines, just waiting for a buy signal. Ironic in that people wait to buy when everything's up. But it really does work that way psychologically. With the market going up, people are confident. And with interest rates going down, GICs and such aren't looking so good. It starts a slow wave of $$ coming back into the market.

That usually continues until something goes wrong. And you never know what black swan event is going to happen. Right now, the confidence and the interest rate movement are really positive for equities in general.

Yesterday was great. We've had some really big moves and are starting to see some M&A activity. Market confidence has to last for a period of time before people say it's time to buy the small companies. They will move and be volatile, but we've had 4 or 5 false starts to a small-cap rally in the last 3 years.

Any time inflation picks up, small caps get a hiccup because they're quite sensitive to rising rates. There's no one indicator that signals a small-cap rally. Things just slowly build until investors get more confident and willing to take more risk.

When people talk about risk in small caps, what they really mean is price volatility. But there are lots of small caps out there sitting on $100s of millions of dollars in cash, and their fundamental risk is not that big. But some of them are much less risky than a large cap sitting on $100s of billions of debt, which will get hit if interest rates go the wrong way.

In Canada, small-cap golds are up 60-70%. Just ridiculous in terms of how well they've done. Starting to see some industrials move. 

Starting to see small caps transition into big caps, and CLS is the best example of that. It went from a dopey little company 5 years ago to today's $30B market cap. ATZ is another example. That's what small-cap investors want to see. 

In general, people are still gravitating toward $2-3B companies rather than $500M companies.

Doesn't think it will get eaten, but a lot of software companies need to adapt. They can either make acquisitions to make themselves more competitive, or hire smart developers to create in-house AI solutions. There will be a lot of angst and a lot of investor uncertainty.

Some will suffer, but others will adapt and prosper.

The Risks of Penny Stocks 101: High Volatility and Illiquidity

Penny stocks have low trading volumes and liquidity. Often, controlling shareholders own 90 per cent of the stock’s float, so that any buyers have to pay ever-increasing prices to establish a stock position. This means that even small trades can have large effects on the stock price, making them extremely volatile and difficult to buy at a decent price.

Even worse, of course, illiquidity makes it even harder to sell at a desired price. And, trust us, if you find yourself owning one of these penny stocks, you are going to want to get out at some point. Movements of 50 per cent or more can be common occurrences. Investors may find themselves completely unable to exit positions without accepting a steep loss or may be stuck holding the bag if buyers suddenly disappear.
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