The Worst Types of Stocks to Buy

Red tape with Danger written on it with bright yellow background

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When it comes to investing in the stock market, not every pick is a sure thing and many well-established companies can quickly turn into the worst stocks to buy.

Take General Motors (GM), the iconic automaker that filed for bankruptcy during the Global Financial Crisis. More recently, amid interest rate volatility in early 2023, Silicon Valley Bank and Signature Bank both declared bankruptcy despite commanding more than $300 billion in collective assets.

These failures of seemingly stable firms are painful illustrations of how all investing carries risk. That said, there are some corners of Wall Street populated by small and risky companies that are much more likely to end in disaster.

There is no universal definition of the "best stocks to buy" or the "worst stocks to buy," as investor sentiment and the economic environment are constantly changing. But if you want to avoid investments that are most prone to trouble, you may want to steer clear of the following areas that are among the worst types of stocks to buy.

The worst types of stocks to buy: Micro-caps

Market capitalization is a common Wall Street statistic that measures a company's total value, based on the current share price time and the number of shares outstanding. A "micro-cap" stock is a company with very small market capitalization, normally $300 million or less.

For a stock with a low market cap, an investment of just a few thousand dollars can significantly move the price – making it ripe for manipulation by bad actors. Think of it this way: For a $10 billion company to increase 10% in a single trading day, there needs to be $1 billion added in. That's a pretty tall order. But if the company is only $10 million in market value, it's possible for a much more modest influx of investor capital to really move the needle.

Unscrupulous investors sometimes target micro-cap stocks for "pump and dump" schemes, where they talk up a given micro-cap stock and wait for others to pump up the stock price. After those gains are priced in, they quickly dump their shares and harvest profits – and the stock quickly falls back to earth.

The smaller the value of a company, the easier it is to manipulate its stock price. So generally, micro-caps are among the worst types of stocks to buy.

The worst types of stocks to buy: Penny stocks

Penny stocks are also found alongside micro-cap stocks, but this group is characterized by incredibly low share prices instead of low market values.

These kinds of investments are incredibly risky for two reasons. The first is the potential for manipulation, as with all other kinds of micro-cap stocks. But the other is that no company would ever voluntarily list its shares for just a few pennies apiece and its stock price has only wound up in that position after a spectacular decline.

Sometimes large companies crash and burn, and it's tempting to think that they are a bargain at just a few pennies per share. But it is incredibly uncommon for a stock that has cratered like that to turn things around and recover.

If you're looking to avoid the worst types of stocks to buy, long-term investors will generally want to steer clear of any stock that has suffered significant declines – particularly those that are now trading very close to zero.

The worst types of stocks to buy: Meme stocks

Meme stocks came into favor around 2020, fueled by a convergence of factors including mobile apps and zero-commission trading that reduced barriers to access. Online communities transparently sharing investing strategies and folks generally having way too much time on their hands during the pandemic also contributed to the gamification of stocks.

There are some success stories you'll read about. Meme stock traders with "diamond hands" who bought GameStop (GME) as a group and collectively held on until they made megabucks. But the problem with buying stocks promoted by online communities is that sometimes bad actors talk up their own investments and then quickly sell – similar to a pump and dump scheme, but this time reliant on the buying power of others. This is particularly true now that Wall Street banks with sophisticated trading desks are aware of the potential of meme stocks, they are intent on front-running everyone else.

Remember that old yarn from mom, something like: "If everyone jumped off a bridge, would you do it, too?" The same applies to meme stocks. It doesn't matter if everyone on the internet is talking about how perfect an investment is … chances are it's either not true, or you're the last to hear about it anyway.