Making the Most of Small Investments

Stock Tips from a Financial Felon

 Wealth creation depends on investing.

The proof is in the pudding. The wealthiest 10% own 93% of all stocks.

However, investing to create wealth is a catch 22 – it takes money to make money.

The U.S. Government makes investing even harder for most Americans by outlawing anyone that makes less than $200,000 a year (non-accredited investors) from participating in certain categories of lucrative investment opportunities like IPOs and private equity.

The deck is stacked against anyone (most everyone) with only a few dollars to put at risk in an investment.

There is little trustworthy advice available for investing a few dollars for maximum returns – so little that you clicked on an article written by a self-proclaimed financial felon.

Disclaimer: I’m not quite a felon. I’ve only been charged as a felon, not convicted. I remain optimistic that my efforts over the past twenty plus years to advocate and blaze new trails for small investors and small businesses will be seen as genuine by a jury of my peers and void of the criminal intentions alleged by a government enforcing prejudicial laws that preclude most U.S. citizens from even participating in much of the investment market.

With only a few hundred or few thousand dollars to invest, the typical, tried and true, buy and hold investment advice delivering an S&P 500 10% annual return does not inspire much enthusiasm.  Besides, stock prices of S&P 500 companies range from $100 to $1000 per share.

Small investors looking for big returns sometimes take a chance on penny stocks – companies with share prices under $5.  Penny stocks have much higher share price volatility than higher priced stocks. In addition to having lower prices, penny stocks generally have lower overall trading volume.  It takes less buying or selling to drive a big penny stock share price change – up or down – than a higher priced stock. A small investment of a few hundred or few thousand dollars into a penny stock has a better chance of generating a hundred percent return on investment or higher than does an investment into an S&P 500 stock. A penny stock investment also has a higher potential of resulting in a total loss than investing into an S&P 500 stock. The trick, of course, is in trying to figure out which penny stocks to take a chance on.

There are approximately 5 million start-ups in the U.S. every year. Estimates for the total annual volume of all seed stage investments vary dramatically. $20 billion is one of the more generous estimates.  That’s $4,000 per start-up – hardly enough to incorporate, set up a website, establish a P.O. Box and open a bank account. Inevitably, some percentage of those 5 million entrepreneurial endeavors are going to end up exploring alternative start-up fund raising avenues – penny stock listings, crowdfunding and cryptocurrency, to name just a few of the more prominent alternatives.

I have spent much of my career working within many of these alternative fund raising avenues to connect small investors with small, early stage businesses in a mutually beneficial relationship. It hasn’t been easy.

As previously mentioned, the U.S. Government limits the types of investments into which someone earning less than $200,000 a year can enter. The burden the U.S. Government puts on small businesses raising capital is even worse.

The U.S. Government financial regulatory warnings against penny stock investments are comparable to the FDA warnings on tobacco products. Until recently, the U.S. Government was doing it’s best to disrupt the cryptocurrency market any way possible. The regulatory implementation of crowdfunding is a far cry from what was intended under the Jobs Act and anyone earning less than $200,000 a year has limited opportunity to participate in crowdfunding offerings anyway.

If I were one to subscribe to conspiracy theories, I might be inclined to think the U.S. Government is trying to drive a wedge between small businesses and small investors.

Yes, investing comes with inherent risk – you might lose your money. It’s safe to say that larger return on investment opportunities come with a corresponding higher risk. Don’t invest what you can’t afford to lose.

When considering a penny stock investment, I suggest limiting your choices to young companies with innovative business plans for high growth. Such companies are publicly listed for the purpose of raising money from the public-investment-in-private-equity (PIPE) market to prove and build their innovative business plans. Keep in mind that most of these companies are ultimately going to fail. These are not long-term investments. Every young company management team is convinced that their company will be the exception to the failure rate of most start-ups – 90% within the first 5 years – but statistically, the odds are against them.

Milestone Investing

Why do I suggest investing in a company that’s probably going to fail? Because most of these companies are going to succeed before they fail. The management teams are going to lay out a series of milestone goals they expect to be the pathway to long-term success. They will likely succeed at reaching a few of the milestones.  In the end, with 90% certainty, they won’t reach all the planned milestones, or they will discover that the planned milestones weren’t the right milestones in the first place. Nevertheless, each milestone a young, innovative company does reach feeds hope that this company just might be one of the 10% that’s going to make it, and the share price has the potential to dramatically demonstrate that hope by increasing precipitously.

Federal Reserve Chairman Alan Greenspan described this milestone share price phenomena as “irrational exuberance” in a 1996 speech titled The Challenge of Central Banking in a Democratic Society.  A share price reflecting irrational exuberance throws a bit of a wrench into the theory of efficient market hypothesis (EMH) around which U.S. Government financial investing regulations are built.

EMH is the idea that share prices reflect all available information. Investment regulations are structured to ensure companies provide full and fair disclosure. The expectation is that share prices will reflect fundamental financial information published quarterly.

According to EMH, it’s difficult to logically correlate a precipitous share price increase based on one milestone success when the company’s quarterly financial statement reports ongoing losses. Regardless, purchasing stock in anticipation of a milestone success can result in a big return on a small investment.

To realize that big return on a small investment, the small investor must sell the stock when the share price goes up. The mistake small investor’s frequently make is to wait for share prices to continue to rise. The abundance of tried and true, buy and hold investment advice leads small investors to think it makes sense to hold on to this stock that just experienced an irrationally exuberant gain. Again, buy and hold advice was developed for the S&P 500, not a penny stock. Unfortunately for the small investor that decides to hold, the precipitous share price increase in the young, innovative company is, most likely, only temporary.   

The irrationally exuberant increase is immediately at risk to short selling. Ultimately, the laws of supply and demand dictate share prices. The price went up because a milestone success created more than usual demand for the stock. Short selling increases the supply of stock, albeit artificially, and the increased supply (selling pressure) brings the share price back down. Once the share price comes back down, this could be a good time to buy again in anticipation of the next milestone success.

There is nothing illicit or shameful about milestone investing in a company that is probably not going to be a long-term success. As a frame of reference, owning founders shares in Amazon and Tesla made Jeff Bezos and Elon Musk billionaires long before either company turned a profit. The founders of WhatsApp, Flipkart, Airbnb, Reddit and Pinterest all became billionaires selling their companies before any of them turned a profit.  Mark Cuban may be the best example of getting rich from irrational exuberance.  He sold an unprofitable Broadcast.com to Yahoo for 57 times revenue of 100 million dollars receiving a total of $5.7 billion in Yahoo stock. If irrational exuberance can make billionaires from companies that have not yet achieved self-sustaining operations, small investors should proudly be able to double or triple or better their milestone investments in young, innovative companies that might never reach self-sustaining operations.

Scammers are out to get your money. Financial fraud scams resulted in over one trillion dollars in losses in 2024. Phishing, identity theft, fake tech support, up-front fees, credit scams and, yes, investment scams put everyone at risk every day – every time you look at your smartphone. All you can do is do your best to avoid ingenuine ploys to separate you from your money. Avoiding scams is a separate subject for a separate article.

With 5 million start-ups per year, there is no shortage of genuine companies looking for investment and doing their very best to succeed. While most of the entrepreneurs will fail, they will make a financial contribution to the U.S. and global economies along the way and maybe even drive innovation that finds success down the line when adapted and adopted by a later entrepreneurial venture. Small business entrepreneurialism is vital to the experimentation that drives innovation, and milestone investing can facilitate a mutually beneficial relationship between innovative small businesses and small investors.