Beware of penny stock promoters. They are usually more interested in boosting their stocks than building their business.

Penny stock promoters love to make deals with major, household name companies. They find it far, far easier to sell stock to the public if Goldcorp, BHP Billiton or some other major mining company has agreed to finance exploration of their mining claims, or if Apple or Intel or some other household-name multinational has agreed to evaluate their revolutionary software or “cloud” application.

The link with a major gives them instant credibility, especially with investors who are willing to buy penny stocks.

Penny stock promoters make companies seem bigger than they appear

When they get a deal with a major, promoters go to great lengths to make it seem bigger than it really is. Instead of announcing that the big company has invested, say, $50,000, penny stock promoters may issue a press release that says the two companies have entered into a “multi-stage development plan”. The release may say the major has agreed to spend “up to $10 million” or whatever. It will usually provide a toll-free number or an online link for investors who wish to order the enticing brochures.

Big companies have more leverage

It pays to remember that a big company doesn’t go into a situation like this the same way you do, as an individual investor. If the big company agrees to spend $50,000 to study the property, program or gizmo, it will also insist on a series of options that let it invest ever-larger sums on favourable terms. But the big company will always reserve the right to drop out and cut its losses. In most cases, it will exercise that right to drop out.

A major mining company will gladly spend $50,000 100 times, and lose every penny of it—a total outlay of $5 million—if this means it will get a chance to develop the one rare project that’s worth the investment of, say, $500,000,000.

If it waits till the property, program or “revolutionary” new software has proven itself, development rights will be much more costly. So it gets in early by investing what are, for it, token amounts of money. That’s why big-company involvement by itself is never a good reason to buy a penny stock.

In fact, when a penny stock shoots up on the news of big-company involvement, and the property/program/revolutionary software is still in the early stages of development, it’s often a good time to sell.

Above all, stick to our three-part Successful Investor strategy:

• Invest mainly in well-established companies;
• Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities);
• Downplay or avoid stocks in the broker/media limelight.

The third element in our strategy is crucial in avoiding stock scams. These penny stock promoters focus on companies that are likely to not go anywhere and other than a connection with some trend, development of industry that is getting a lot of media attention. It takes a lot more than that to create a profitable business or investment. But if you let the media hoopla taint your investment decisions, you increase your risk of blundering into a promotional stock like pot o’ gold.

Have you ever invested in a new stock after receiving an enthusiastic recommendation from from a penny stock promoter? What was the single most important factor in your decision to invest? Did it work out? Would you ever do it again? Let us know what you think.

Note: This article was originally published in 2013 and has been updated.