How to Invest in Penny Stocks
Penny stocks, or micro-caps, are a much maligned investment option due to the negative press they receive driven by often unscrupulous activities that plague the industry. Pump and dumps, the practice of artificially inflating a stock price in order to sell stock at a higher price, is the most well known tactic used by many penny stock owners and shareholders.
These practices are actually present in every equity market, the effects on micro cap stocks are pronounced due to relatively less liquidity, low investor sophistication and a lack of information.
And while penny stocks are inherently more risky that larger cap stocks, such as those listed on the NYSE and NASDAQ, it should be remembered that some of the largest companies listed in the United States were once considered penny stocks. There is no better example than Apple, which in 1996-1997 traded below $4. It is now trading at $420 and is the largest company in the world by market value. Other examples of stocks that now trade above $25 but were once considered penny stocks include Green Mountain Coffee Roasters Inc, Netflix Inc, and VirnetX Holding Corp.
Penny stocks can provide for tremendous growth opportunity in one's investment portfolio if you know what to look for.
First, doing your homework is critical. Take a look at the industry the company operates in. Is it a growth industry? Is there potential to expand overseas? Are there any political or regulatory burdens the company faces?
You must take the time to read through all of the company's SEC filings. This will help you understand the business they are in, and how the company is performing now, and plans to grow in the future.
Look for red flags. Has the company changed its name, ownership and industry over the years? Does the company rely heavily on related party transactions for its revenues, or loans? Has the CEO or senior management ever been the subject of an SEC inquiry?
You also need to do research on the company's management team. Do they have a history of running or growing companies? How relevant is their previous experience and education? A reputable and trusted management team is a critical factor when deciding whether to invest in a penny stock.
Finally look closely at the company's valuation. While it is often expected the penny stocks have little revenues, and/or high debt levels (especially start up companies), the value of the company should reflect this. If the value of the company is not in line with its financial statements, and there is no adequate explanation for this, there could very well be manipulation of the stock. In which case, stay away.
These practices are actually present in every equity market, the effects on micro cap stocks are pronounced due to relatively less liquidity, low investor sophistication and a lack of information.
And while penny stocks are inherently more risky that larger cap stocks, such as those listed on the NYSE and NASDAQ, it should be remembered that some of the largest companies listed in the United States were once considered penny stocks. There is no better example than Apple, which in 1996-1997 traded below $4. It is now trading at $420 and is the largest company in the world by market value. Other examples of stocks that now trade above $25 but were once considered penny stocks include Green Mountain Coffee Roasters Inc, Netflix Inc, and VirnetX Holding Corp.
Penny stocks can provide for tremendous growth opportunity in one's investment portfolio if you know what to look for.
First, doing your homework is critical. Take a look at the industry the company operates in. Is it a growth industry? Is there potential to expand overseas? Are there any political or regulatory burdens the company faces?
You must take the time to read through all of the company's SEC filings. This will help you understand the business they are in, and how the company is performing now, and plans to grow in the future.
Look for red flags. Has the company changed its name, ownership and industry over the years? Does the company rely heavily on related party transactions for its revenues, or loans? Has the CEO or senior management ever been the subject of an SEC inquiry?
You also need to do research on the company's management team. Do they have a history of running or growing companies? How relevant is their previous experience and education? A reputable and trusted management team is a critical factor when deciding whether to invest in a penny stock.
Finally look closely at the company's valuation. While it is often expected the penny stocks have little revenues, and/or high debt levels (especially start up companies), the value of the company should reflect this. If the value of the company is not in line with its financial statements, and there is no adequate explanation for this, there could very well be manipulation of the stock. In which case, stay away.
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