Penny stocks are so called because of their relatively low value. Yet, penny stocks remain a popular investment for some as the ROI can be substantially higher than that of normal stock purchases. It is the prospect of reaping a quick windfall that entices many investors to delve into the penny stock marketplace. However, as indicated earlier, penny stock investing is a highly speculative enterprise that, should the investor’s instincts prove to be wrong, can exact a hefty penalty.
If you have been contemplating entering the penny stock arena, there are some precautions you should take before diving in head-first. The first order of business is to set aside a specific amount that you are willing to risk before making the purchase. This way you won’t be thrown into financial ruin should the stock you pick turn out to be a bad choice. Many an investors have found themselves wringing their hands in regret after letting the lure of a major windfall blind them against investing wisely.
Even though the ROI for penny stocks are substantial, you should still try to find out why a particular stock is considered such a risky investment. The fact of the matter is that most of these companies have a poor financial track record. For example, companies appear to operating on solid financial ground because they have a large portfolio, but upon closer scrutiny you might discover that, because of unsound business practices, they are no more than conduits for moving money along with no real value. In addition, some of the penny stocks listed are manipulated by scam artists.
Again, do not let the lure of a big payday lure you into making a costly investment. Before jumping on a stock simply because it has a low value, and assuming that it must have a great rise one day, take some time to familiarize yourself with investing first. During this self-imposed orientation period, you could engage in some less risky stock purchases like mid and large-cap stocks. This way you could acclimatize yourself to the volatile world of stock trading. You should also make an effort to understand balance sheets, income statements, and the cash flow of a business before trying to figure out what are the best penny stocks to buy.
Finding the best penny stocks requires more than just the luck of the Irish; it also involves you making a concerted effort to learn everything you can about penny stocks: what make them so potentially lucrative and so dangerous at the same time. Therefore, an immersion into the inner workings of things like cash flow, market capitalization, and share structure is essential. Also, gaining an understanding of what the purpose of a publicly-traded company is, how prevalent scams are, what happens to your stock when the company issues a new one, and how the purchase of penny stocks affect your investment value.
If you’ve done your homework, you should be able to spot which stocks to avoid at first sight. For example:
Stocks that aren’t commonly traded on U.S. exchanges
Companies whose annual revenue does not exceed $10 million
Companies that promote their stocks via email campaigns
Companies in an industry that you have very little knowledge
Watch out for Scams
The prevalence of scams in the stock market cannot be overstated. They have made a business out of robbing you of your hard-earned money. One method used for scamming are email campaigns mentioned earlier. The messages are usually prefaced with enticing phrases like “top penny stocks,” or “hot penny stocks.” or “best penny stocks.” Phrases like these should be seen as a red flag, as the nature of penny stocks is that they are highly speculative and risky.
Another scam perpetrated upon unwary investors is stock dilution. Under stock dilution, a company issue more and more stock shares into the market until it becomes saturated, rendering the stock virtually worthless and robbing you of your investment.
Look for Cash Flow
When looking through a list of penny stocks for a potential investment, look for companies that have shown some consistency in their ability to generate cash flow. As stated earlier, some companies can appear to be solvent, but under closer scrutiny they are heavily indebted. If so, this is a clear sign that the company is financial insolvent and, therefore, wouldn’t be a worthwhile investment. A smaller, lesser-known company whose stock value hasn’t had time to rise or catch the eye of investors, and yet their financial statements show that they are fiscally responsible would be a safer bet for penny stock speculators.
Another thing you should take into consideration when viewing a penny stock list is how the price per share compares against the book value per share. For example, a stock valued at $3.99 per share could seem more enticing than one valued at $3.00, but because the company is so heavily indebted that its liabilities outweigh its assets, the $3.99 stock’s book value is less than the $3.00 stock. This is another area where intimate knowledge of financial statements and cash flow comes in handy.
Since penny stocks are so risky, you may want to keep them at no more than five percent of your investment portfolio. Again, business acumen and shrewdness dictates that you approach penny stocks from a cautious standpoint. A wise businessman would do everything in his power to maintain the health of his portfolio, and limiting investments in speculative stocks is one way of doing so. Remember, stock trading is a business, not a hobby. This means that it should be approached with the intent of making money, and limiting loses. Simply asking yourself the question, “will this investment make me money?” should go a long way in helping you decide whether to purchase a stock or not.
Finally, when handled correctly, penny stocks can result in handsome rewards for the investor. However, the very nature of penny stocks means the road to riches via this route is littered with hazards. The key is to learn how to avoid the hazards by acquiring as much knowledge about the field as possible. Armed with knowledge and tempered with caution, penny stocks can be a worthwhile investment.