How to Find Penny Stocks

Finding Penny Stocks

Understand what penny stocks are. In general, penny stocks are common stocks that sell for $5 or less per share. (The term will sometimes be applied to slightly higher-priced stocks.) Their low price makes them an attractive bet for some investors, but committing large sums of money to small, unestablished companies can be dangerous. Many investors do not consider stocks that sell on the New York Stock Exchange (NYSE) or other large exchanges to be penny stocks, regardless of their price. These exchanges have vetted the companies they list, and this provides an air of legitimacy that stocks sold "over the counter" (directly by a dealer) typically do not have.

Know the risks of investment in penny stocks. A great many investors stay clear of penny stocks, considering them too inherently risky. There are, in fact, certain risks to investing in companies that may lack brand recognition or a proven record of profitability. Many companies issuing penny stocks are not well known and may not be subject to the public regulation imposed on larger firms. Small companies that are sold over the counter and are first entering the market do not even have to file complete accounting records with the SEC (Securities and Exchange Commission). Similarly, although all publicly traded companies are required to report their assets, liabilities, and profits, there is a feeling among some investors that certain small companies do not necessarily report these figures accurately. The failure rate of many penny stock companies is very high. To suggest that most of these companies go out of business quickly would be misleading. However, when compared to firms that have higher stock prices, companies with penny stock offerings go bankrupt at a comparatively high rate. Penny stocks are especially vulnerable to price manipulation. In schemes commonly referred to as "pump and dump," certain investors will promote a company whose stock they hold with the aim of raising the market value of the stock and then selling their own shares, sometimes very profitably. Larger companies with higher-priced stock do not lend themselves well to this tactic, but it does occasionally work with less well-known stocks. Penny stocks are one of the risky trades. To be listed on major exchanges, you have to trade at over $5. A lot of penny stocks are under $5. So, that makes it very risky. Another big risk of penny stocks is the lack of transparency. Many penny stocks do not have the same financial reporting requirements as major stocks. Penny stocks are also very volatile because they have a small float that people can manipulate. They have limited liquidity.

Consider the potential benefits of penny stock investment. Despite the risk, many investors are willing to take certain chances on penny stocks. The potential for profit is great, and not all penny stocks present the same risks. Some are shares issued by established companies that for whatever reason have come to be considered over-valued but still possess certain worthwhile assets. To generalize about all penny stocks is to ignore significant differences between them and thus lose out on the chance to make substantial profits.

Locate information on penny stocks. The best penny-stock information is provided by dealer organizations. The two most recognized publications of penny stock information are the Pink Sheets and the Over the Counter Bulletin Board. Many companies that are not on the major exchanges list their stock information through the Pink Sheets—a daily, online publication produced by the National Quotation Bureau. The bid and ask prices of the stocks are listed by the Pink Sheets, but keep in mind that companies on the Pink Sheets are not required to provide any information to the SEC. The Over the Counter Bulletin Board is an inter-dealer quotation system and electronic trading service offered and regulated by the National Association of Securities Dealers. It lists real-time quotes, most recent sale prices, trading volume, and other information related to thousands of different stocks. All companies listed on the OTCBB must provide their information to either the SEC or an insurance or banking regulator.

Get to know a dealer familiar with penny stocks. The market for penny stocks is inherently opaque. These companies simply do not get the attention or publicity that major corporations do, and the marketplace can be difficult for an outsider to understand. Work with an advisor who operates in a "fiduciary" capacity (someone legally required to work in your best interests) so you can learn the market before investing.

Investing Wisely

Ignore the hype. There are a number of questionable sources of stock tips available to investors. Many of the penny stock newsletters are actually advertisements funded by companies with low-priced stocks. Read the disclaimers that usually accompany these publications. Focus on factual information about a company and ignore those who promote stocks without mentioning profitability or the value of assets.

Determine the value of a stock by examining intrinsic values. Before investing in a stock determine how much the stock is or should be worth. Focus on the following points: The value of the company assets versus liabilities. This can be tricky because not all companies are as scrupulous about providing a full description of net worth. Dividends, or payments from the company to its shareholders. Most penny-stock companies are not going to pay a lot, but the payment of even a few dividends would normally suggest that the company is at least turning a profit. The market volatility of the stock. Has the stock risen and fallen dramatically in the last several months? If so, why? Has there been questionable leadership, or are they tied to a commodity or service that has fallen out of favor? An intelligent reading of the volatility can help identify value while also considering the risk involved in an investment. The vision of the company. Especially for a new firm attempting to raise capital through a stock issue, companies must demonstrate that they have a vision, a plan for the future. Who will the customers be, and how will they grow in number? How will the company use the money raised by this stock sale?

Be prepared to buy or sell quickly. Because penny stocks can be so volatile, you may need to trade them in a hurry. In particular, if you have purchased shares which subsequently double or triple in value in a matter of weeks, you'll have to consider selling them quickly before the market reconsiders. You may be inclined to sit back and enjoy the ride, but unless you predicted this kind of swing based upon your estimate of the company's actual value, the stock could easily become over-valued and due for a crash.