Definition of a Penny Stock
A penny stock is any stock with a price less than $5.00. I personally like to add the criteria of market cap less than $500M. In theory a $1.00 stock could have a total larger market cap then a $100 stock. So I prefer to consider market cap over price.
Why Buy Penny Stocks
Penny stocks offer investors a unique situation with much greater return potential then larger companies.
For example a $300M upcoming company with a stock price of $1.00 could triple to $900M and $3.00 and still be considered a small company but the chances of a $100B company tripling are rare.
The Process
1. Use a stock screener to identify penny stocks Yahoo and Google finance have free ones available the one below is Google's
2. Add Criteria (Last price.) set 0-5.
3. Set Market cap 0 - 500M
Investment Rationale
Determine if you prefer to pick a sector you believe will perform better in the future or if you would rather use some other selection process such as P/E ratio. For example I believe with the high price per barrel any small cap / penny stocks in the energy sector will do well going forward due to the fact their profit margins are becoming more attractive with rising prices.
Check Recent News
Check Reuters.com Key Developments for the stock you selected. This helps eliminate noise and useless articles that stock websites list in the news section. With Key Developments you get more relevant news. Look for major events such as customer losses, pending bankruptcy, or any deal breakers that will cause you to look somewhere else.
Check Income Statement for Revenue and Net Income
I prefer to only buy penny stocks with revenue which means I will never buy a pharmaceutical penny stock with one product pending FDA approval. I prefer to invest my money, if I want to gamble I will go to a casino. I also prefer to buy a penny stock with net income or revenue growth that will soon show positive net income. Any financial site that allows you to view income statements will do
No Revenue or Profit Start Over
If the company is not making any money after all their expenses they will run out of money and go out of business. (There are a few exceptions if you really want to get into non cash expenses and free cash flows but in general no net income = risky investment.)
Look at a Ten Year Chart
When you are looking at the stock quote click ten year chart and determine if the stock has always been a penny stock or if something caused it to become a penny stock. Find out the cause and determine if the company can overcome the loss.
Open up an Investment Account
Share Builder
Etrade
Scottrade
Set Return Goal
Determine the return you would like to achieve in a one, three and five year period such as 20% year one 50% year three and 100% year five. If the penny stock reaches your goal sell it. If you don't set a return goal it's very likely you could see your value up 50% then back to the price you paid for it within a few months.
Determine Investment Amount
Consider your net worth, rule of my thumb no more than 5% of your net worth in an aggressive investment.
Calculate return to cover commission
Optional Step
One great resource is a company's investor relations website. You can browse through presentations or annual reports to view company projections and uncover nice facts but remember their job is to sell their stock. If the company can't even put together a nice investor relations site it might be a good sign to run away.
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