Those who are new to investing may not understand what penny stocks are. You will typically find penny stocks on over-the-counter markets. According to the SEC, the definition of a penny stock is any equity that trades below $5. You will soon learn that this pricing is justified in a few moments.
On top of this low pricing, penny stocks are inherently risky and very volatile. This volatility is what results in “penny stock success stories” where investors are making 100% returns in a single trading session. If you read any of the articles on PennyStocks.com, we discuss the ups (and downs) of penny stocks and how investors were able to capitalize.
The important thing to remember is that if you plan on investing in penny stocks you should know the signs of a strong stock. As you continue reading this article, you will gain more exposure to what makes a penny stock worth 1 million dollars.
Penny Stocks & A Fundamental Focus
By far, the most important thing any investor can do is conduct proper research. Remember, penny stocks are very speculative and volatile by nature so the least you can do is spend some time researching. When conducting your research, you should do a deep dive into a company’s financials.
You will soon realize that a lot of penny stocks have sketchy financial statements, avoid these at all costs. Only put your money into companies that are transparent and have strong financial backing.
When conducting fundamental analysis, you should look at a few things. Evaluate the company’s debt ratios, free cash flow, and even the potential for a buyout. Though the last item isn’t big in certain industries, when you think about things like mining stocks, acquisitions are very popular among junior gold stocks, for example. One of the best things to happen to a small-cap company is a buyout from a larger, more established one.
This tends to result in a large increase in the stock price and a strong foreseeable future. We saw this earlier in 2019 when we were tracking the FitBit (FIT Stock Report) buyout with Alphabet (GOOGL Stock Report) doing the purchasing. You can get more on this from the article, “Penny Stocks To Watch: Fitbit (FIT); Readers Win Big.”
Conduct Industry Life-Cycle Analysis
You might be asking, what exactly is a life-cycle analysis? It is the process of analyzing what stage an industry is in at a given point in time. There are 4 stages: expansion, peak, contraction, and trough. Based on where the industry is, an investor determines whether or not there is potential in the industry as a whole.
Most penny stocks tend to come from sectors that are in their early phases. This stage is known to have a large amount of smaller companies with low customer demand for products. The companies also have high costs compared to revenue due to early research and development. All of these factors are the reason why penny stocks trade at cheap prices and are considered speculative.
The moment that investors are looking for is when a company moves into the growth stages. This is characterized by larger market attention resulting in higher sales. Some of the more stocks to watch in this regard are biotech penny stocks. Within the blink of an eye or the release of a PR I should say, a penny stock can quickly become a formidable market leader. Case in point, in October we began to follow a company called Aurinia Pharmaceuticals (AUPH Stock Report).
More On Aurinia Pharmaceuticals
At the time the penny stock traded around $4 a share, so the higher end of the penny stock range. As share prices rallied and speculation grew, it all came to a head after the company announced positive Phase 3 data for its Lupis therapy. The result was a run to highs of over $20 a share; 400% higher than where it was just a few months prior.
Do Penny Stocks Offer More Opportunities?
Whether you are investing in small, medium, or large-cap stocks, it is important to understand the industry you are putting your money into. Some industries offer something known as binary outcomes. A binary outcome is considered very speculative, make or break, investments. Some examples of these include resource and tech penny stocks which you have seen us mention quite a few times.
To understand the speculative nature of a binary outcome I am going to compare it to the tech bubble in 2000. There was a commodity boom as well in 2000 on the Canadian exchange where a lot of resource companies exploded. They then crashed in a similar fashion to the tech bubble popping and became nearly worthless.
If you are planning on putting your money into a binary outcome you should be very careful. These stocks can fall as quickly as they rise. On top of this, if you plan on investing in these you should get in when they are experiencing favorable conditions. Something that has come up recently focuses on large, name-brand companies tumbling amid scandal.
Household Name Doesn’t Mean Much In The Eyes Of The Stock Market
Just because a company is a household name doesn’t mean it’s good to invest in. Take Sprint (S Stock Report) for instance. We reported on this company as it had just begun to slide warning readers about some of the big risks posed by the company’s actions. Needless to say, Sprint made new 2019 lows during the 4th quarter and hasn’t recovered yet. Keep this in mind when doing your research.
As another example, we saw something happen with marijuana penny stocks. Would you believe that at one point Canopy Growth (CGC Stock Report) traded below $5 a share? Despite the pullback in the industry, the pot stock trades above $15 a share and previously won a multi-billion dollar investment from Constellation Brands.
Penny Stocks & Company Management
One of the most essential things for any small-cap company looking to make it big is strong management. If you really think about it, how is a company supposed to establish itself without proper leadership and guidance? A change in leadership could be the difference between a failing company and a company primed for big things.
Furthermore, those in leadership tend to have a vested interest in the company so they want to see it do well. This gives investors that feeling of safety because it feels like the management is trying to protect its investment as well.
Of course, this is much easier said than done. When you think about “top-quality” management you think of CEOs who run Apple or Proctor & Gamble. However, these aren’t the folks running most penny stock companies. This is why it is important to learn about incoming management and their backgrounds because they could make or break your investments.
Final Thoughts On Penny Stocks
To recap, only invest in penny stocks if you have a high-risk tolerance to handle the volatile and speculative nature. Also, on this same note, many pro traders use a basic rule of thumb to only invest what you’re willing to risk 100% of. If you do find a company that interests you, make sure they have sound financials and a strong management presence. Doing this will enhance your chances of hopefully finding that diamond in the rough.