Making money in the stock market can be a daunting task. One decision you’ll need to make is deciding whether to invest in penny stocks or blue chip stocks. Both have pros and cons, so how do you decide which is best for you? Let’s take a closer look.
What Is a Penny Stock?
A penny stock is a low-priced publicly traded security, typically with a per-share price of less than $5. Because of their low price, penny stocks are considered highly speculative and risky investments.
Penny stocks are typically traded on over-the-counter (OTC) exchanges, which are markets that are not regulated by major stock exchanges like the New York Stock Exchange (NYSE) or the Nasdaq.
OTC markets are often referred to as “pink sheet” markets due to the color of the paper that was once used to list the prices of these securities.
While penny stocks may seem like a bargain, they are also considered risky investments. This is because these securities are often issued by small, unknown, and potentially unstable companies.
Additionally, penny stocks are often subject to fraud and manipulation, so it is important to be very careful when considering an investment in one of these securities.
Why Is It Called a Penny Stock?
Penny stocks got their name because they used to trade for “pennies on the dollar.” However, the US Securities and Exchange Commission (SEC) reclassified these types of shares, so they are no longer technically penny stocks.
Don’t let the name fool you – these days, penny stocks can trade for much more. It usually refers to shares that trade for less than $5 per share.
And while some legitimate companies trade in this range, the vast majority of penny stocks are low-quality companies with little to no revenue.
Even though they are no longer called penny stocks after reclassification, these shares still tend to be very low-priced and volatile.
They are also often associated with fraudulent activity, so investors must be very careful before investing in them.
What Is a Blue-Chip Stock?
A blue-chip stock is a large, well-established company with a history of stable and strong financial performance.
Blue-chip stocks are typically considered less risky than other types of stocks and often pay dividends.
While there is no definitive list of blue-chip stocks, the term is typically used to refer to stocks of companies in the Dow Jones Industrial Average (DJIA), which is one of the oldest and most well-known stock market indices. 
Some examples of popular blue-chip stocks include Apple Inc., IBM, and Coca-Cola.
In general, blue-chip stocks tend to be less volatile than other types of stocks, often providing investors with a measure of stability and income potential.
However, it is important to remember that all stocks come with some risk, and even blue-chip stocks can lose value.
Why Is It Called Blue Chip?
Blue chips are the highest-valued playing pieces in the game of poker, where the term “blue chip” originated.
In the business world, blue chips are those companies that are leaders in their industries and have a long history of financial stability and success.
Investors often see blue chip stocks as a safe bet since these companies have proven themselves resilient over time.
These companies are typically large, well-established businesses with a global reach. They also tend to pay regular dividends, providing investors with a steady income stream.
These companies have strong fundamentals and are less likely to be impacted by economic downturns. They also have the financial resources to weather tough times and continue growing their businesses.
Penny Stocks vs Blue-Chip Stocks
When it comes to investing in stocks, there are two main camps that investors tend to fall into: those who prefer penny stocks and those who prefer blue-chip stocks.
Each has its advantages and disadvantages, and which one is right for you will ultimately depend on your individual investment goals and risk tolerance.
Dividends
Penny Stocks
Penny stocks are less likely to pay dividends, meaning that you’re not likely to see any return on your investment unless the stock price goes up.
Blue Chips
On the other hand, blue-chip stocks have a history of paying regular dividends to shareholders. Blue chip stocks have proven to be reliable income generators over time.
These companies have strong fundamentals and a history of profitability, and they’re more likely to continue paying dividends even during tough economic periods. This makes them an ideal investment for income-seeking investors.
Growth Potential
Penny Stocks
Penny stocks are generally issued by smaller, less established companies and have a lower possibility of long-term growth.
However, since penny stocks are highly volatile and risky investments, it also means that there is a great potential for high rewards if the stock price does go up.
Blue Chips
Blue chip stocks offer a more steady long-term growth potential than penny stocks.
This is because they tend to have strong brand recognition and customer loyalty, which gives them a competitive edge in their respective industries. This can provide some downside protection if the overall market experiences a downturn.
Volatility
Penny Stocks
Penny stocks are more volatile than blue chip stocks.
Blue Chips
Blue-chip stocks tend to be less volatile than penny stocks, which means they’re less likely to experience sharp declines in value during market downturns.
This makes them a more conservative investment option, which can be appealing to risk-averse investors.
Blue-chip stocks offer a great way to invest in reliable companies without worrying about many ups and downs. So if you’re looking for a little more stability in your portfolio, consider adding some blue chip stocks to your mix.
Market Capitalization
Penny Stocks
Penny stocks tend to have a market cap of less than $500 million.
Blue Chips
Blue-chip stocks boast a market cap of $10 billion or more. That means that, in general, blue-chip stocks are much larger companies with higher valuations.
Market capitalization, or “market cap,” is a measure of a company’s size calculated by multiplying the total number of shares outstanding by the current share price. It’s one way to gauge how much a company is worth on the open market.
Do Penny Stocks Ever Go Big?
Yes, penny stocks can go big, but it is rare. For every penny stock that makes it big, thousands fail.
True Religion is one of the great examples of a successful penny stock. The company was acquired by Towerbrook Capital Partners in 2013 for $32 per share, representing a nearly 5,000% increase for long-term investors who held onto the stock.
Despite filing for bankruptcy in 2017 and 2020, True Religion remains an excellent example of the potential for penny stocks to generate significant returns.
Monster Beverage Corporation is also one of the most successful penny stocks in recent years. This company has seen its share price skyrocket from under 6 cents per share in the early 2000s to over $70.
This represents a return of over 142,761% for investors who were brave enough to buy shares in this company when it was trading at rock-bottom prices.
Another example is Medifast Inc. This company was trading at less than $2.30 per share in 2005 but hit an all-time high of $246.97 in 2018.
This represents a move of over 10,000%. However, it should be noted that this took place over 13 years.
Is It Worth Buying Blue-Chip Stocks?
Yes, blue-chip stocks are widely considered by investors as one of the safest stock investments, and it’s because of the proven benefits of blue-chip companies in the past years.
Blue-chip stocks are more likely to be investment grade, meaning they are considered less risky by lenders and investors. This can make them more attractive to potential investors.
Many blue chip stocks offer consistent dividend payments, which can provide income for investors. Dividends are typically paid quarterly or annually, so it’s a plus factor in your decision-making process.
Blue-chip stocks often have more weight in stock market indices like the Dow Jones Industrial Average or the S&P 500. This can be beneficial for investors who want to track the overall market performance.
Blue-chip companies are old and reputable. This can give you some peace of mind knowing that the company has withstood the test of time.
Not to mention, a blue-chip company’s creditworthiness is superb. Blue-chip companies can repay their debts.
Be sure to look at a company’s balance sheet and income statement to understand its financial health.
Lastly, a blue-chip company has a history of consistent growth. This can be measured by looking at things like revenue, earnings per share, and other financial metrics over time.
Final Thoughts
So, should you invest in penny stocks or blue-chip stocks? The answer is that it depends on your goals and market risk tolerance.
While penny stocks may come with more risk, there can also be greater reward potential.
If you’re comfortable with those risks and believe that a penny stock is undervalued, go for it! But remember not to invest more than you can afford to lose.
On the other hand, blue chips are considered safer investments with consistent dividends, but they typically offer lower short-term returns than other types of stocks.
So if you’re looking for high returns, penny stocks might be a better option. However, if safety is your number one priority, blue chips might be a better choice.
Ultimately, it all comes down to what you’re comfortable with and your goals.
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