Typically, penny stocks do not pay dividends since penny stock companies tend to either be small companies with little revenue or larger companies that are undergoing financial hardship. However, there are a few that offer dividends, and investing in dividend-paying penny stocks can reduce the overall risk exposure of a penny stock portfolio.

Key Takeaways

  • Penny stocks are usually defined as stocks trading for less than $5 per share whereby most trade via over-the-counter.
  • Investors can use a stock screener to find dividend-paying stocks by adjusting the search filter for stocks under $5 and a dividend payout.
  • A dividend-paying penny stock can help mitigate part of a portfolio's loss or improve the percentage gain on a profitable portfolio.

Understanding Penny Stocks

Penny stocks are usually defined as stocks trading for less than $5 per share with some of them listed on major stock exchanges, such as the New York Stock Exchange (NYSE) or Nasdaq. However, most penny stocks are traded over the counter, which is a broker-dealer network that buys and sells stocks via the over-the-counter bulletin board (OTCBB) or through an OTC listing service called the pink sheets.

In the past, the title "penny stock" was reserved for stocks of companies that traded for less than $1 per share. However, the definition was changed by the U.S. Securities and Exchange Commission (SEC) to any stock under $5 per share.

Although not all penny stocks pay dividends, they are out there. Dividends are cash payments made to shareholders from the companies as a reward for being an investor.

How to Find Penny Stocks That Pay Dividends

One simple method of locating dividend-paying penny stocks is doing an online search through a search engine using phrases, such as "penny stocks that pay dividends" or "list of penny stocks that pay dividends." The search-engine results should provide a partial list of dividend-paying penny stocks.

Another method is to use a stock screener whereby an investor can first screen for penny stocks by applying the filter of a maximum stock share price of $5 per share. The investor can then apply the additional filter of only the stocks with a dividend payout ratio greater than zero to the resulting stock list. An investor could add additional criteria to the search, such as only penny stock companies that have generated earnings or profits as well as dividends.

It's important to remember that a company must have generated profit over several quarters or years to have enough retained earnings or cash saved in order to pay consistent dividends.

How Dividend-Paying Penny Stocks Can Boost a Stock Portfolio

The majority of penny stocks may not provide enough of a return on investment from the appreciation of the share price to justify the investment. As a result, many penny stock trades lose money. Purchasing dividend-paying penny stocks is a way to improve the overall investment return realized from a portfolio composed of penny stocks.

For example, suppose an investor purchases 1,000 shares each of three penny stocks, all selling for exactly $1 per share. Over the course of a year, the share price of stock A remains unchanged, the share price of stock B drops to 50 cents and the share price of stock C doubles to $2 per share. The investor's net return on investment (ROI) for the year is $500, resulting from no change in stock A, a $500 loss in stock B, and a $1,000 profit from stock C.

Suppose each of the three stocks paid an annual dividend of 5 cents per share. The dividend payments increase the investor's net profit by $150, or 3,000 total shares times $0.05, a more than 20% improvement in ROI.

Investors should note that dividends alone do not guarantee profitable penny stock trading. In the example above, stock B is still an overall losing investment even with the dividend payment. However, the dividend payment helps to mitigate the loss.

Risks with Penny Stocks

Since small companies typically have their stocks trade over the counter, there is little financial information about them. As a result, small penny stock companies lack the market liquidity, meaning there aren't enough buyers and sellers available sometimes for the stock. Investors who buy a penny stock might not be able to sell the stock when they want to because there are no buyers in the market.

With the low liquidity and the lack of financial information, the prices offered in the market for a penny stock can be different from the price listed on an online investment website. In other words, the real market price can be quite different than a published price since the broker might charge a wide spread or fee to account for the risk of not being able to find a seller for each buyer and vice versa. Also, as with any investment, but particularly so with penny stocks, investors could lose all of their initial investment.