In one sentence: Phil and Danielle ask why anyone would use penny stocks: volatility, thin data and boiler-room scams are the downsides, and the speculation only goes away when you value the business and would be happy to own it at the price, as Phil did with Activision.
Key ideas
- Quick recap of the dangers. Penny-stock prices swing wildly, little financial data is required, and boiler rooms buy quietly, cold-call buyers, let the price jump, then sell into the demand. Phil says this is illegal but hard to police because the operators move around. [03:00–05:00]
- The bid/ask gap is the broker's profit. In this corner of the market the gap between what sellers ask and buyers bid is wide, so brokers earn a lot on small trades. That is one reason the pitch keeps coming. [05:00–06:00]
- Don't assume every call is a scam; do the normal homework. Understand the business, check it has a moat, and look at management, the same as for any stock. [06:00–07:30]
- Why mispricing is more possible here. No Wall Street analysts cover these companies, so pricing errors can be large. Phil says that is unusual on the main market, where he instead looks for an event to create the error. A novice should not expect to find the gold nugget easily. [08:00–09:30]
- Activision as a worked example. Microsoft agreed to pay $95 a share while the stock sat near $75 because regulators might block the deal. Phil's team had a value view: happy to buy near $75 and more if the deal failed and it fell toward $60. Whichever outcome occurred, they were content ("anti-fragile"). They ended with about 18% of capital in the trade. [10:00–14:00]
- Selling calls to reduce basis. They sold long-dated call options at $95 on the shares they owned. Buyers paid a few dollars a share betting that the stock would break out if the deal failed. Phil framed it as being the casino and collecting the premium, which lowered cost basis and raised return. Options need their own episode. [14:00–18:00]
- Speculation is about your confidence, not the price chart. If you are content to own the company long term, the volatile price no longer makes it speculative. [17:30–18:30]
- Franchise analogy: your name is on the door. Owning a Domino's franchise without experience would be very risky; a celebrity such as John Elway can run car dealerships by hiring experts. Owning a stock is hiring a CEO, so management quality is paramount. Phil links this to Graham's insight that you own a business. [19:00–24:00]
- Why people really use penny stocks. Two honest reasons: small accounts can buy whole shares of cheap stocks, and you might get in early. The common reason is gambling on the chance of tripling a 10-cent stock in days. Phil adds that the number of shares doesn't matter, only the percentage of the company you own. Danielle does not like fractional shares because the intermediary holds the share. [24:00–33:00]
- Rumor boards are the new boiler rooms. Reddit's WallStreetBets and similar boards can move a tiny stock with a few dozen people, and a recent international phone scam was cited. [27:00–30:00]
How it maps to RuleOne
- Phil's diversification target of 10–20% in a position and 5–10 companies fits the portfolio view on /holdings/.
- The screen's event watch on / is the same idea as buying Activision on regulatory fear; the rest of the screen focuses on listed companies where filings are reliable.
- Selling calls to reduce basis is the R (reduce basis) part of the method, though the site does not automate it.
Buffett, Munger and Graham links
- Graham's "a share is a piece of a business" (The Intelligent Investor, chapter 8 on Mr. Market) is the point behind "your name is on the front door".
- Speculation as a matter of what you know, not the instrument: Graham's definition of investment in The Intelligent Investor, chapter 1.
Words to know
- Boiler room: a cold-calling operation that promotes thinly traded stock to inflate its price.
- Bid/ask spread: the gap between the best buy and sell prices; the broker or market maker profits from it.
- Anti-fragile: happy with more than one outcome, and not hurt by the bad one.
- Call option: the right to buy shares at a set price by a set date; selling one earns a premium.
Try this
Pick any listed stock you follow from /stocks/ and write the price at which you would happily buy more if it fell 20% for no change in the business. If you cannot name one, you are speculating on the price.
Check yourself
- Why can an amateur still find mispricing in penny stocks?
Answer
No analysts cover them, so errors can be big. But the data is thin and scams are common, so it is not a novice's field. - In the Activision example, why was buying at $75 not a bet on the deal?
Answer
They had a value view and would buy more at $60 if the deal failed, so either outcome was acceptable. - What does selling a covered call at $95 give up and gain?
Answer
It gives up gains above $95 and collects premium now, reducing the cost basis.
Short quotes
"As long as you're content to own the company, it isn't speculative." (paraphrase of ~18:00, auto-transcribed)