Transcript: Are penny stocks getting the memestock treatment?

This is an audio transcript of the Behind the Money podcast episode: ‘Are penny stocks getting the memestock treatment?’

Michela Tindera
Hey there, BTM listeners, it’s Michela. I wanna give you a heads-up about next week’s show rather than our regularly scheduled Wednesday episode. You can look for us in your feed a day early on Tuesday, March 19th. That’s because we’re doing a special two-part episode with our friends over at the FT’s Unhedged podcast. You’ll find one part of the show in the Unhedged stream and another part in our stream. But until then, here’s this week’s episode. Enjoy.

[MUSIC PLAYING]

The other day, I was on the line with the FT’s US markets editor, Jennifer Hughes, and I wanted to show her something. So I’m actually going to play a few clips for you and tell me if you can’t hear them. But here it goes.

Audio clip
This morning I made $10,355.41 in 32 minutes of day trading. I turned an account with less than $600 into more than $10mn. Today, I’m gonna teach you how to turn $100 into $30,000 in 60 trading days.

Michela Tindera
OK, so Jen, I’m just kind of curious hearing these clips. What are you thinking? What does this remind you of?

Jennifer Hughes
It sounds like the memestock mania from 2021, when we had those small caps like GameStop and AMC go crazy and everybody was talking about them.

Michela Tindera
What Jen’s describing here is how in 2021, struggling companies like the video game store GameStop and the movie theatre chain AMC saw their shares take off. The surge in price was propelled by retail investors. That’s everyday people trading on apps like Robinhood.

Jennifer Hughes
There was so much going on back then in terms of Reddit, StockTwits, these other online forums where people are like, yeah, buy this stock, it’s got the greatest future. Or there’s that sort of trend where people will say, if we are all going together, all the little guys get together, we can sock it to the big hedge funds and, you know, save our companies, the ones that we love.

Michela Tindera
But those clips you just heard actually aren’t from 2021, and they’re not talking about GameStop, AMC or any of the other memestock favourites. They’ve all been posted more recently, and the people who made them are focused on trading something else: penny stocks.

Jennifer Hughes
These are tiny, tiny companies. In this case, we are talking about companies whose shares really are trading in pennies that is less than a dollar a share.

Michela Tindera
Jen says that the number of penny stock companies listed on public exchanges, like the Nasdaq, has more than quadrupled in just the last year.

Jennifer Hughes
It’s currently about 470 after the trading sub-dollar. What is interesting in that, though, is that this time last year, there were less than 100 that were trading below the dollar.

Michela Tindera
But it’s not just the number of companies that surprises Jen. She’s also noticed something else that’s peculiar.

Jennifer Hughes
What we’re seeing here is really a boom in the trading volume of these shares. So when we say volume of shares, we’re literally talking about the number of shares.

Michela Tindera
If you look at a list of public companies in the US ranked by how many shares are exchanged on a day-to-day basis, that’s trading volume. And Jen says that she’s noticed that some of these penny stock companies are topping that list. They’re beating out big companies like Tesla and popular ETFs like the S&P 500. This activity has caught the attention of major public exchanges and traders.

Jennifer Hughes
You shouldn’t normally have a company that’s worth, say, $2mn out trading a company like Tesla, which is worth, what, $570bn or something.

Michela Tindera
So what’s exactly going on here? And are shares in these companies the next rocket that’s headed to the moon?

[MUSIC PLAYING]

I’m Michela Tindera from the Financial Times. Today on Behind the Money, retail investors are driving a new boom in the public markets trading penny stocks. But why is this happening? And what’s it mean? Hi, Jen. Welcome to the show.

Jennifer Hughes
Nice to be here.

Michela Tindera
So these penny stocks also known as sub-dollar stocks. They’re these tiny companies. So how does trading these work? Can I buy shares the same way I buy into Google or Coca-Cola.

Jennifer Hughes
You can pretty much do it through any regular broker. Charles Schwab or say Robinhood. It’s really no different to buying Apple shares. It’s just a lot cheaper per share.

Michela Tindera
What are some examples of companies that I could buy that are a part of this penny stock group? Have I heard of any of them?

Jennifer Hughes
Probably not heard of many of them. Some of the ones that have attracted attention: a company called Phunware — spelled p-h-u-n, ware — which is a mobile software developer. And there was another called Bit Brother. That was the most traded stock in the US in December. Bit Brother is, or it was, a small chain of Chinese tea shops but it is switching its focus, it says, into blockchain and cryptocurrency mining.

Michela Tindera
That’s quite the pivot. So how does a company end up in this place where it’s trading for less than a dollar?

Jennifer Hughes
It can happen in different ways. It could be that a business doesn’t perform so well. It starts making losses and its share price falls. Another way is a lot of these companies are ones with prospects down the line that might not have made money yet. Small electric vehicle makers, biotech companies sometimes fall into this bucket and they might have to raise more capital, but their share price is fallen in the meantime. Another group is the ones where they were small companies, but the share price has fallen partly because they’ve had to do these bad financing deals, which has really diluted their share count and pushed down the share price.

Michela Tindera
And it’s a big deal for your company shares to fall below a dollar, right? It has some extra significance compared to, say, your company’s shares dropping from $20 to $10.

Jennifer Hughes
Trading below a dollar matters because that’s the nominal level at which an exchange like Nasdaq or New York Stock Exchange will look at delisting the company. They say the shares are just too cheap, they’ll be too volatile and they’ll consider delisting it. It’s a process that takes time, but if you are trading sub-dollar, you are at risk of being removed from the exchange.

Michela Tindera
So what’s the appeal here for retail traders? I mean, why go for a penny stock over a Tesla or an Apple?

Jennifer Hughes
It’s kind of the moonshot thing that we saw with the memestock. These are guys, they might not be spending as much time trading, these retail traders. They’re not spending as much time trading as they did in the pandemic. But maybe they’ve kept up the trading habit. And you buy something like a share in Apple or Tesla. And that’s what, 160, 180 bucks a share. For that same money, you could spread a lot of risk. You could buy shares in smaller companies. And if you get a few moonshots, then you’ve probably made a lot of money.

Michela Tindera
Yeah, it’s the possibility of getting rich quick.

Jennifer Hughes
Yes. Well, at least making money. I’m not sure buying shares at $0.10 is going to make you an absolute fortune, but you should make money.

Michela Tindera
So isn’t the reputation of penny stock trading, it’s a bit seedy? I mean, I’m thinking of like a scene from The Wolf of Wall Street where Jordan Belfort shows up at this brokerage to sell penny stocks.

[CLIP FROM THE WOLF OF WALL STREET]

Jordan Belfort
Six cents a share? Oh come one, who buys this crap?

Broker
Well, I mean, honestly, mostly schmucks. They see our ads in the back of a Hustler and Popular Mechanics, and our ads actually say they can get rich quick.

Michela Tindera
What’s the reputation here? Is that true?

Jennifer Hughes
Yes. It’s not something that an ambitious company executive would like to be thought of for very long at all. It means companies that are very risky often have sudden changes in their business models. A tea shop that wants to become a cryptocurrency miner. It’s the risky end of the market. They don’t have analysts covering them. You don’t have broker research, so it leaves investors very much on their own trying to figure out what this stuff really means. It’s not where you’d want to put your retirement money.

Michela Tindera
So in some ways, the memestock mania of 2021 and the penny stock fever of 2024 look similar. Retail investors have played an important role in both, but how alike are they really? More on that after the break.

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Michela Tindera
So Jen is what we’re seeing here — this penny stock trading phenomenon — can we call this memestocks 2.0?

Jennifer Hughes
Yes and no. On one hand, a lot of the traders, the retail traders are the same. Trading is something of a side hustle. Just something you might make a bit of money from. That’s bit the same. But memestocks were about small investors getting together and effectively ganging up on what they perceived to be the evil hedge funds that were shorting the shares that they loved, like GameStop or AMC. This penny stock trading we’re seeing now, this isn’t about ganging up. We’re not seeing that, per se.

Michela Tindera
Yeah, there’s not really that broader set of ideals around the little guys banding together to take on the rich and powerful here.

Jennifer Hughes
It’s really just about betting that some of these stocks do come good. Perhaps the biggest difference is really that in the GameStop meme-stock era, that period, then we saw the share prices rocketing. But now we’re seeing trading volumes shoot up, but lot of the share prices are actually falling.

[BOMB DROP SOUND EFFECT]

Michela Tindera
Hmm. But if more retail investors are piling into this space, wouldn’t that drive the share price up? I mean, why is it falling?

Jennifer Hughes
So the background to this is we’ve got higher interest rates. So it’s harder and more expensive for companies, particularly small ones, to borrow money. So a lot of these guys have turned to loans that are tied to their shares. So in very general terms the lenders to this companies, the lenders have this choice whether they get paid back with cash or they take shares. What’s been happening is that a lot of the lenders have opted for shares. So the company then has to issue fresh shares to fulfil their loan terms. That’s the contract of the deal. That then increases their share counts.

Michela Tindera
Ah, I see. So these companies end up flooding the market with new additional shares. And then that ends up diluting the value of per share. And then the share price falls.

Jennifer Hughes
Yes. Now in many cases, that’s made worse still, because the lender gets the shares at a discount and often sells them immediately. So kind of dumps them in the market. So you have more shares and you have more trading volume. And some deals are structured so badly, in my view, for the companies that the lender can go and do this several times over. And that means that you just got this effect where there are new shares, the share count is rising, the share price is falling, and then someone is dumping a bunch of those shares into the market, which is pushing the price down further.

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Michela Tindera
Now, Jen, you interviewed one attorney who’s an expert in this area, and he called what you’re describing here the quote unquote, death spiral, which doesn’t sound so good. So are retail traders aware of what’s going on here?

Jennifer Hughes
That’s one of the reasons I thought it was important to do this story, to look at this because I’m not sure that they do necessarily. From reading the comments I can see in some of the online forums, people are talking about the potential for some company to, said, shoot for the moon — the phrase everyone likes to use. You know, say it’s business is gonna come good. This is going to happen. But what I’m not sure they’re aware of is that however good the business is, and I could question some of those too, it may well get undermined and the share price might be undermined by this financing, which nobody’s really talking about because it’s technical and very dull to read the filings about it.

Michela Tindera
What impact is this penny stock trading having on the broader market, if any?

Jennifer Hughes
It doesn’t have a massive impact on the overall market. It’s just more this, in fact, that we’ve seen it several times over in the last year or so. Where penny stocks, risky stocks have suddenly become the most traded for a while and then disappear from sight again in terms of trading volumes. And that’s what’s getting people’s attention, that it’s not just one it’s sort of a cycle that happens again and again.

Michela Tindera
And then why does that cycle keep going?

Jennifer Hughes
So it’s kind of like one element is that retail traders didn’t disappear after the pandemic. There’s still lots of guys hanging out in chat rooms talking about these. Another is the idea that we’ve got more penny stocks. So there’s more at the really cheap end of the market for people to play with.

Michela Tindera
Now, a number of these penny stock companies are traded on the Nasdaq. Is there any reputational risk to Nasdaq having companies like this on their exchange? I mean, what’s Nasdaq say to this?

Jennifer Hughes
I should say that both Nasdaq and the New York Stock Exchange have small companies. Nasdaq does have a lot more of them because part of its emphasis, part of its story, has been about helping smaller growth companies. Now, Nasdaq does have rules that eventually would delist companies that are trading below a dollar if they can’t boost their share price above that level in a certain time. And it has come in for criticism that it hasn’t been strict enough in applying those rules. That’s something that it does deny. It says it follows its processes. And it is also worth noting in the space, it’s a really tough area to regulate. Say you delist a sub-dollar stock. You might also be cutting off a company from financing and basically forcing it to go to the wall. Plus, some companies go through tough times that they recover from. I mean, one person pointed out to me that Citigroup dipped below a dollar per share during the global financial crisis, and obviously that recovered pretty well.

Michela Tindera
So as you’ve seen this trend play out, we’ve seen these kind of swells of trading of penny stocks come in, come out. What do you see happening next year? Any potential for regulation or what should people be watching out for?

Jennifer Hughes
We’re still working through regulation. That was initially triggered by the memestock mania three years ago. So I wouldn’t expect anything to come from this particular sort of penny stock episode in the near future, unless we see something totally crazy develop. It’s penny stocks. So really, who knows?

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Michela Tindera
So, Jen, if I decided tomorrow that I wanted to get into penny stock trading. What would you tell me? What would your advice be?

Jennifer Hughes
(Laughs) My advice would be a bit like the advice that people always give you if you go to Las Vegas, only gamble what you can afford to lose. There’s no guarantee you’re gonna make money out of these guys.

Michela Tindera
Jen, thank you so much for being on the show.

Jennifer Hughes
You’re very welcome.

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Michela Tindera
Behind the Money is hosted by me Michela Tindera. Saffeya Ahmed is our producer. Topher Forhecz is our executive producer. Sound design and mixing by Sam Giovinco. Cheryl Brumley is the global head of audio. Thanks for listening. See you next week.