Where Can I Trade Stocks For Cheap (?) And Why It Might Not Be Such A Good Idea To Do So!

Especially when the stock markets have consolidated and broken down significantly, thousands of bargain hunters are on their way trying to find and buy dirt cheap stocks in the hope of cashing in large profits with these cheap trading stocks once the markets go up again!

And even beyond this scenario investors, a lot of times beginners, are in quest of buying cheap stocks whether they are penny stocks, undervalued stocks or any other alleged “great” cheap stock.

But when exactly is a stock cheap?

For many investors a stock is only cheap when it trades within the $10 to $20 range or even way lower than that, trading within a few dollars or even cents, which is why these stocks are also called penny stocks or also over the counter (OTC) stocks. But the peril is, especially with penny and otc stocks, that there’s a reason why these stocks are trading at these give-away-prices.

More often than not there’s some bad news surrounding these companies whether it has to do with fundamentals, management, earnings or other factors. Or - which most often is the case with otc’s - they just haven’t met the stringent requirements to be listed in one of the major stock exchanges like the Dow Jones. So something is just not kosher with these cheap trading stocks. And it would have to be scrutinized very carefully if you contemplate investing in these kind of dirt cheap stocks.

In my early rookie days of trading I fell for 2 dirt cheap stocks myself. I bought Bank Internasional Indonesia (the 6st largest bank in Indonesia) for 3 cents and KrungThai Bank (being the 2nd largest bank in Thailand) for 64 cents thinking that a bank stock must go up at some time. They can’t stay so dirt cheap forever. But they did. Worse even: Shortly after I bought this “hot” cheap stock of Bank Internasional Indonesia it dropped down to 2 cents. Cheap penny stock Krung Thai dropped by 50%. And why did these stocks like lots of other financial stocks in the far east drop to penny stocks? Because of the asian financial crisis 2 years before. Not having recovered yet I, like lots of other investors too,  thought that a recovery is not far away. Wrong!!! These 2 banks are still extremely dirt cheap penny stocks!

But especially when advertising campaigns for cheap trading stocks are spreading through the internet with slogans like “hot cheap stocks”,  “best penny stocks”, “dirt cheap stocks with growth potential” or “cheap stocks to buy now” your alarm bells should start ringing! If these stocks are that brilliant, why is it then necessary to advertise for them in such a way? And at the latest here is where your stock research starts. Before even dreaming of investing in these kind of stocks, research them very very carefully. There’s a very high risk involved! Remember, you’re not buying General Electric, Microsoft, Wall Mart or Apple.

I wrote an article on these kind of stocks called “OTC Penny Stocks And OTC Bulletin Board Stocks - Never Fall For This Nonsense!!!” where some people tried to get me into buying utter junk. You should go ahead and read this article too. You’ll find it on this website. Within 2 years now, not one of these stocks  that were offered to me has moved up by even a cent. Not one! They all went down even further.

They all would’ve been good for a short trade!  But there was nothing mentioning that! It was proclaimed that these super-duper dirt cheap stocks would go through the roof making you a killing of a profit. So don’t fall for this nonsense! Rather read my article! These kind of “where can I trade stocks for cheap” scams are nothing but junk trading tips without any quality.

The only ones getting filthy rich are the people behind these scams that try to show you how to invest in cheap trading stocks and tell you all about hot penny stocks, cheap stock of the week, penny stock secrets and that you can retire from you day job within a year if you follow these penny stock recommendations.

Another one of these scams I got via email was “five dirtcheap stocks for getting filthy rich video”. The only one that got rich was the person or organisation that sold these videos. So in your own interest, exercise extreme caution when someone comes with investing in Dirt cheap stocks!

Now don’t get me wrong. I’m definitely not saying that it is entirely impossible to make money with penny stocks or stocks that are cheap. All I want to point out to you is the extreme risks these stocks bear and that a lot of these stocks are not only dirt cheap, but also dirt cheap scams! So just be very careful!

For others a stock is only cheap when the price-earnings ratio (P/E ratio) is low. So the lower the price-earnings ratio the better it is for them on speculations that it will go to where it was before the stock dropped, if it goes up again.

To recap. A price-earnings ratio is a measure of the price paid for a share relative to the annual income or profit earned by the firm per share  It is determined by dividing current stock price by current earnings per share (adjusted for stock splits). A higher multiple means investors have higher expectations for future growth.

The thing about P/E ratios is that conservative investors should avoid stocks with a high P/E ratio because if these corporations disappoint with their earnings and don’t meet market expectations, the stock will drop dramatically like Whole Foods did dropping more than $20 at the beginning of November 2006.

If a stock has a low P/E ratio, where expectations aren’t that high, the reaction is far less dramatic if earnings and performance expectations aren’t met.

If trading and investing in the stock market was that easy, everybody would just buy these so-called good cheap stock, best penny stocks or stocks with a low P/E ratio. To bad so sad that no one would have then had Starbucks in their portfoilo. A stock that shot up sky high in the past. A low P/E ratio didn’t exist in Starbucks vocabulary back then in the good days of Starbucks!

If you disregard individual stocks that have dropped sharply and take a look at the broad market, you’ll surprisingly notice that a P/E ratio tells you absolutely nothing about whether a stock is going to go up or down in the future! Not only stocks with a high P/E ratio can drop, but also stocks with a lower one can.

A good example of the above is the following:

Within the last 4 years the Dutch financial company ING, having a low P/E ratio, climbed to the skies from $10 to over $40. That’s over 300% profits, whereas AIG (American International Group), also having a low P/E ratio, was virtually dead in comparison.

On the other hand, Starbucks and the German cosmetic company Beiersdorf kept on going up although both companies had a high  P/E ratio whereas Whole Foods, also having a high P/E ratio, dropped from $80 all the way down to $40 in 2006, and EMC² is still hovering around $15 and hasn’t recovered yet since 2000 where the stock was trading at just over $100.

So as you can see, there are no rules whether a stock with a high or low P/E ratio is good or bad!

Why doesn’t the P/E ratio strategy work?

The problems already start at the very beginning. Which earnings should one take into account? The reported earnings from the previous year; the expected ones for the current year or even the forecasted earnings for the next year?

Because the stock market mainly looks at future performance and earnings, the future P/E ratio plays a more important role. But even the expected earnings of the current year can only be estimated let alone the one for next year. It all boils down to estimation and speculation which is quite common in the stock market. But if these estimates are wrong and market expectations aren’t met, investors are then commonly very disappointed and the stock or even the whole market goes down. And this happens every year somewhere along the line.

And this is not the only reason why a P/E ratio is not a good formula for success. The furure performance of a corporation depends on so many factors. A future stock price doesn’t only depend on earnings from the current year or the next. It also depends largely on fundamentals like, how well the management does it’s job, whether the company has a strong product line or which possible problems the company may face.

An example of this is Apple (AAPL). When CEO Steve Jobs introduced the iPhone in Jan. 07, AAPL shot up by over $10 in two days. But then Cisco Systems (CSCO) claimed that they had the rights to the name iPhone and were contemplating to sue AAPL if they were to continue using the name iPhone. Well. Guess what happened? AAPL went down the following days losing it’s entire $10 gain.

So once again you can see that a P/E ratio, whether high or low, says way too little to base an investment decision on because the question you should ask yourself is not, how to buy cheap stocks and where to get them, because they are all over the show, but you’ve got to ask yourself, does it make sense to buy the one or other cheap stock and where can I make money with it without taking too much of a risk?

Conclusion:

At the end of the day, a P/E ratio, or any other ratio, or whether a stock is cheap or not is absolutely irrelevant. What matters most importantly in the long run are earnings and the overall performance and future outlook of a company! Short-term factors like oil prices, political turmoil etc. can influence the markets and they will, more often than not! But in the end these factors are secondary and negledgible for long-term investments.

Successful Trading!

Ricky Schmidt