Penny stocks appeal to some investors. For example, considering that these small public companies trade their shares for a couple of dollars, investing in their stocks provides a more affordable approach to stock investing. There are also other advantages. Some of these companies can have a growth potential. This makes them ideal for growth investing. Their volatile price movements also make them suitable speculative stocks for speculative investing and intraday trading. They are also relatively accessible through various avenues like over-the-counter markets and brokers. However, considering their high risks and the fact that a lot of penny stocks have been implicated in fraud, there are disadvantages. Nevertheless, if your risk appetite leans toward the aggressive type, it is important for you to understand how to pick the right penny stocks to minimize your risk exposure and maximize your investment potential.
Important Considerations: A Definitive Guide to Picking the Right Penny Stocks to Minimize Your Risks and Maximizing Your Investments
1. Look for registered companies with actual operations
There are a lot of penny stocks to choose from. However, more often than not, some of the companies offering these securities have dubious reputations. There are companies that claim to operate in the United States but are mere shell companies in reality. It is important to pick ones that are registered with the Securities and Exchange Commission or in relevant agencies of other countries where the companies claim to operate.
It is not enough to choose registered companies. You should pick those with actual operations and market presence. This means that the prospected companies should be producing or selling goods or services. The market for their products should be existing or that there are actual customers that are purchasing these products. Their entire business model should be clear. You should be able to discern from plain sight how revenues are generated.
2. Choose companies with published audited financial statements
Another important marker of a legitimate public company is if it publishes financial statements. These documents detail its business activities, revenues from sales, profit margins, expenses, and overall financial health. The data from these financial statements are also used for performing fundamental analysis and other models of internal analysis. Note that public companies are required by law to disclose their financial information.
The financial statements must also be audited by independent third-party accounting firms to ensure that all details in the reports are accurate and are assessed by objective accountants free from undue influence. The financial reporting should also adhere to established accounting standards like the Generally Accepted Accounting Principles or International Financial Reporting Standards to guarantee consistency and comparability.
3. Select those with customers who can vouch for their products
Remember that some companies that offer penny stocks tend to be mere shell companies with no actual operations and solid business models. There are also those with existing operations but have a suboptimal market presence. It is important to invest in companies with customers that can vouch for their products. This serves as a proof-of-concept that validates the product-market fit and a demonstration of the potential for recurring revenue and growth.
Nevertheless, in looking for evidence that their products are doing well, the common course of action is to look check online reviews from independent platforms like social media, forums, and news media publications. It also helps if these companies or their products have received awards or commendations from reputable organizations like industry publications, trade organizations, award-giving bodies, and government offices or agencies.
4. Use tools and resources to aid in making informed decisions
There is a wealth of information and a selection of platforms available online that can help individuals interested in investing in penny stocks make informed investment decisions. Websites like Yahoo! Finance and Benzinga maintain active and up-to-date lists of top-performing penny stocks in the U.S. stock market. Several trading platforms like Charles Schwab, Fidelity, and Interactive Brokers have historical data on stock prices.
A tool called a penny stock screener can also help in picking the right penny stocks. It specifically aids in sorting through a large selection of penny stocks based on specific criteria. The criteria can include specific price points, market cap, industries, trading volume, and financial ratios. These criteria act as filters to help in narrowing down the selection process. Yahoo! Finance and Finviz are free screeners. StocksToTrade.com is a paid screener.
5. Look for companies with growth potential in emerging markets
It is important to note that some small public companies can be considered as growth stocks. Hence, in consideration of growth investing, another tip in picking the right penny stocks is to choose those with a high growth potential. This can be determined through the level of innovation in terms of product offerings, the attractiveness of the markets their products serve, and a strong management team with clear visions, among others.
Examples of penny stocks with a potential for growth are startups that aim to disrupt markets or have solid value propositions that can challenge incumbents, those that are banking on innovations like artificial intelligence, established companies that are expanding their product lines or charting new markets, and reputable companies in emerging markets or developing economies but with shares that trade within the penny stock range.
6. Choose penny stocks that are in line with your exit strategy
A clear exit strategy is a predetermined plan for selling or liquidating your investments at the right time and under a suitable set of circumstances. It can involve one or more considerations. These include price targets or the price point at which the shares will be sold to earn profits or limit loss, stop-loss orders or an automatic command that halts trading activities if a price falls below a predefined level, and time-based targets or time horizons.
Note that not all penny stocks are as liquid as other penny stocks and stocks from established large-cap and even mid-cap and small-cap public companies. A clear exit strategy should also take into consideration the liquidity of the prospected penny stocks or the ease of selling them in the market. An illiquid stock can be difficult to sell. The common markers for these are adequate levels of trading volume and availability in accessible trading platforms.
