Penny Stocks Investment Guide.

invest in penny stocks

Penny stocks investment are risky most of the investors turn their back from them. But diamonds are always found in coal mine. I certainly agree that most of penny stocks are not worth investing. Some of these businesses are so badly beaten that there is zero probability of their recovery unless they are merged or acquired by some other company.

Sure that there stocks are very risky and cut your account down to half within few months. But as Warren Buffett says ‘risk comes from not knowing what you are doing.’ If investor have information advantage and knowledge advantage then there can be better opportunities in this arena.

As said previously penny stocks are riskiest investments and many of them to choose from. Hence investor must be very choosy while selecting them. If there is something that is not understandable or inconsistent then move on to the other.

penny stocks investment
Penny Stocks Image source : Screener.in

In this article we are going to discuss about some important points for penny stocks investment which will help you to find great opportunities. I am not talking about swing trade or trade based on the news but a investment backed by strong business fundamentals.

Adequate Volume

There are examples where people invested lot of money in penny stocks when stocks was in trend. Then suddenly liquidity dried up and their got stuck for very long period of time.

Checking normal volume in penny stocks is very important. So that when investor know he is wrong or stock have reached to its maximum potential (in case he is right) he can get out smoothly.

No matter how good stock is looking if there no liquidity according to invested capital then locked money will cause huge opportunity loss.

Good thing about this check  that it will eliminate 60-70 % of penny stocks from probable investment list.

Turnaround

Many businesses become member of penny family just because when their business was running good they take some wrong decisions. Like taking excess of debt which later became problem, incorrect forecasting of future demand that lead to more than adequate capacity building.

Many of them have great business model great working culture and some of the best management. When such companies go for turnaround most often they succeed. So if investor have any such company in mind he should track company’s performance very closely.

As turnaround is not an overnight process it takes may be year or more. The clue of direction (positive or negative ) of where turnaround strategy is going can be obtained from quarterly and annual results. Newspaper is also good medium to get information if company is large enough to catch media’s attention.

When turnaround is successful early investors get huge premium. Because when company business turn toward southward direction it loses all of premium it has. When company get backs into the business then market takes premium into consideration.

Over optimism and over pessimism work in favor of smart investors . But one important thing to know here that turnarounds are rare and more often fail. So investor should proper understanding of all the aspects of business to properly forecast future.

Patents and Copyrights

Coca Cola become multibillion dollar company with just single unique formula. Patents and copyright do have a value. Companies that have some unique patent or copyright are more likely to get successful turnaround.

Such companies are also more likely to be acquired by other competitors just for their brand names and trademarks. Acquisition helps early investors a lot.

True value of each and every intangible assets cannot be identified by the balance sheet. For this investor have to so product analysis and industry analysis. Brand names, trademarks and patents are very helpful quicker recovery in sales.

Management and Promoter Share Holding Pattern

If management have significant portion of company’s shareholding then there is incentive to increase value of a company, so that their shares would be more worthy.

If above thing is not true then management will  not try that hard to grow the business. In this case management will be more focused on keeping company alive so that they get salary on time.

A strong promoter who have good knowledge about that industry can be proved very helpful. Also if a promoter group any large conglomerate or a group then in future they can pour huge sums in business, to bring it back to track.

If promoter is individuals then one more check is necessary how many percentage of their wealth is in company. If say promoter is billionaire and hold 80 percent of stake in company but value of that stake is only couple of million then he may not give that much attention to business.

Signal

Sudden management buying of shares in large quantity only mean one thing. That they have a faith in company and things can much better in future. Thus keeping track on changes in shareholding for penny stocks can be helpful to find good stock.

Change In Management

Competent management is requires to do extraordinary things in business. Just like one creative person (Steve Jobs ) changed whole face of Apple when he rejoined company.

I know everyone is not Steve Jobs but some managements are so stupid that they ruin a quality business.

Businesses which are inherently good but are in trouble due to bad managerial decisions can be fixed quickly with change in top level.

So investor must keep eye on such developments. But sole change in management does not mean company will do better in future. For that investor must assess decisions taken by new management. Usually closing loss making division and focusing on only core profit making business is good decisions (as seen in the past). Investor can also wait for effect to be seen in numbers.

Also Read | How To Evaluate management Of Company

Industry

Company who has industrial tailwind generally do better than some declining or matures industry .

For example when corona virus hit the world, there was huge up serge in medical expenditure. Because of this Pharma industry got tailwind specially in developing countries like India. In such period most of the Pharma stocks showed gains of 60-70 % within the months but penny stocks lying in that industry almost quadrupled in same period .

This penny stocks raise at much faster pace. Because either these companies have low profit margins so when growth wave hits they are one who get most percentile grains. Many companies that are bearing losses for couple of years starts to earn profits.

Corona virus spread was an extraordinary event but there are some tailwinds that last for years. Like finance companies made tons of money between 2010-2020 in India  as economic conditions was favorable and huge credit growth was there in period.

Picking up stocks in growing industry is much more better that picking a company in matured or declining industry.

Business Model Change or Core Business Shift

All business have good period in which they show tremendous growth. But then things slows down, business stops growing at all. Market values growth such no growth companies at very low multiple.

At this stage business have lot of capital but no room for growth. The better option then, is to shift to another business either by new acquisition or by gradually forming a new division. Starting a complete different business is very hard thing. And honestly it rarely works. But there are many cases in which companies tuned to another business successfully.

Best example of this is biggest conglomerate in the world BERKSHIRE HATHAWAY it was spinning mill with no profit at all. Warren Buffet used capital of this business to buy growing business like insurance, candies etc.

Off Balance Sheet Items

There are some off balance sheet items which add significant value to company. Having off balance sheet items do not mean that company will surely become successful. Rather it has less chances of failing.

List of some of these items :

  • Network of distributors.
  • Relationship with suppliers to procure raw raw material.
  • Unique production cycle.
  • Required Know How.
  • Operating Experience.

As penny stocks investment are risky it is not recommended to invest more then 10% of portfolio in any such company.

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