Penny stocks have long been considered highly speculative investments. While the public hears “penny stocks” and thinks pennies, the reality is that penny stocks are defined as issues trading below $5 per share, and many of them trade on the major stock exchanges.
Penny stocks are typically volatile and risky due to their high potential reward. While thee are legendary stories of penny-stocks turning out to be worth millions, you’ll have to look hard for the key signs of success — and be dedicated to the due diligence — to find winners.
Fundamentals, Fundamentals, Fundamentals…
Look for penny stocks with sound fundamentals; as with all investments, investors should properly research their picks before taking any wild chances. Examine the company’s earnings, corporate filings, what industry it’s in, how its industry is performing and whether the industry has massive upside potential. You should also look into its debt, cash flows, revenue growth, and merger-and-acquisition potential, just to name a few.
The industry a penny stock is in is important. You generally want to avoid penny stocks in an industry with a history of companies going bankrupt after one negative catalyst. With that in mind, you would want to avoid most issues in the biotech, pharmaceutical or natural resources industry, where one drug failure or negative news item can kill off fledgling players. If you are looking at penny stocks where a binary outcome — boom or bust — is likely, you’re looking at a plain old gamble, and probably notone you want to take.
Look at the company’s management. A strong management team can potentially put the company on the right path of growth, which could send the penny stock flying. You want to see whether a company has an experienced and ethical management team that has, at one point or another, worked successfully in the industry the company is in.
For example, Amazon.com Inc (NASDAQ: AMZN) had a strong management team, and was able to execute on all cylinders. The stock went from a penny stock to nearly a $1,000 stock. Here’s a look at AMZN on the monthly chart.
Penny stocks are risky and highly-speculative investments, but they also can offer high potential rewards. Don’t let their reputation scare you away, so long as you are willing to do the proper due diligence and dig deep before making an investment.
Taylor Conway is the lead day trader at PennyPro.com. He is a short-term day trader of stocks and ETFs.