Penny hopefuls or penny dreadfuls?

For patient investors who have a high risk tolerance, the rewards can be worth the gamble

- PAM WALKLEY

If, like many fellow Australians, you're up for a punt, then it may be worth considering speculating on the sharemarket. There are plenty of speculative stocks, sometimes called penny stocks, for you to choose from. But, of course, choosing the right ones is quite tricky because there is not a lot of independent research into smaller companies listed on the ASX.

Indeed, many of today's blue-chip shares (stocks that are well known, high quality and often market leaders in their industry) started life as micro-cap stocks. For example, Altium (ASX: ALU) was a penny stock less than a decade ago and now has a market capitalisation of $4.9 billion, points out The Motley Fool (fool.com.au), provider of investment guidance, both free and premium, to investors worldwide.

But beware: not all penny stocks become blue chips!

Penny stocks usually trade for less than $1 and sometimes for only a few cents. Typically, they are young, micro-cap companies (below $5 million) that don't pay a dividend. Their price is usually more volatile than for larger, more established companies.

These stocks can seem like a bargain, but whether they are or not depends less on their share price and more on their fundamentals. Their potential to grow and generate profits is the most important consideration.

The low cost of penny stocks can lead investors to believe they have the potential for exponential growth, but trading them can be risky with a high potential for loss and even fraud, says The Motley Fool.

This doesn't mean you shouldn't consider them, because they can achieve strong returns. Early investors in small, fast growing companies can capture substantial gains compared to later investors who wait until those companies have grown, points out The Motley Fool.