Selection is the Name of the Game
Finding the penny stock gems in any market requires careful study and sometimes also a special intuition. On the web pages Penny Stock Investing: A practical Guide and Learning Penny Stock Skills you have read about investing in the stock market and the reasons why penny stocks can be hugely profitable. You have learnt that flourishing, strong companies are the backbone of great stocks, and also that you can make a lot of money by buying the stocks of major companies when they were small and their stocks cheap. You need a strategy when investing in penny stocks, a system which will assist you in separating the winners from the losers. Finding the real penny stock gems will require rigorous study, but can be an exhilarating experience.
The ABC of successful penny stock selection lies in the selection of companies. Thus the same criteria for buying all other stocks are also applicable to penny stocks. So, what do you have to look for in small companies that will convince you to buy their stocks? There are a few factors to look at:
- Product: Has the company got a product to offer that can compete effectively with opposition in the same niche? Or, has the company identified a potentially lucrative business opportunity to take advantage of, and consequently got its nose in front of other potential competitors? For instance, to deliver essential software for cell phones in a developing country.
- Profitability: Does the company make money and can you go by its financial reports? What are its debt levels? Has it got a substantial bank balance to fund expansion and development?
- Growth: An excellent instrument to measure a company’s growth is Headline Earnings per Share (HEPS). This is calculated by considering after-tax profits, less preference dividends and less items which fall outside the main activity of the business, divided by the number of ordinary shares issued. The percentage increase of HEPS on a yearly basis should rise for a considerable period of time (three years preferred by many analysts and portfolio managers).
- Management: Is the company managed by reputable, trustworthy people and do they communicate properly with the shareholders? Do they publish financial reports on time? Are they not involved is insider trading? A point to remember: If directors of the company are buying its shares (in a legitimate way), it’s a good sign, because it demonstrates confidence in the company. You are entitled to contact the company if you have questions. In fact, you can pay a personal visit to its head office to form an opinion of the degree of efficiency which is exercised in managing the business.
- Resilience: How resilient is the company? How do external factors such as interest rates, inflation, fuel price or other unexpected events impact on it? If a share goes against the trend, for instance its price goes up, when most of the shares in that specific sector tend to go down, it may confirm that the company whose shares you possess, can resist bad market conditions and is internally strong.
A second method to find the gems among the penny stocks to invest in, is to consider what is termed technical analysis. A variety of indicators presented as graphs shows statistics on shares and market sectors. Using these indicators can give you an indication of the current achievements of market sectors, and also assist you in selecting the best stocks in a specific sector. The great value of technical analysis is that it assists you in your decision when to buy and when to sell a stock.
Finding the best penny stocks has become a scientific endeavor. For instance, James Connelly (also known as the “Penny Stock Prophet”) has developed a formula according to which he applies a tool, Psychological Support Level (PSL) with four variables to predict the movement of undervalued stocks.
Adverse economic conditions during which stock prices fall, at times offer good buying opportunities. Often when the stock market’s big indexes are struggling, investors turn to the small/micro cap sector, where you find the penny stocks. Penny stocks are not so closely linked to general market movements. When the big investors begin to spend big money in the small cap sector, this signifies greater liquidity, which in turn brings bigger gains for the penny stock traders.
Also, as a result of the decline in stock prices, many excellent stocks become undervalued, which means that buyers have the opportunity to acquire those stocks at a considerable discount. Quite often, penny stocks with huge potential can be picked up at ridiculous prices. You should always be on the lookout for such bargains.
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