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I consider the following information to be a 'companion' for my previous SeekingAlpha post titled "How to Become a Millionaire on a $100 Investment".  I encourage you to review that blog before proceeding with the following information.
 
 

First, let's review:  What is a penny stock?

In layman's terms, this is a common stock that trades for less that $5 per share and typically is traded on the 'over the counter' (OTC) or outside of the major stock exchanges such as the NYSE or NASDAQ. A great number of penny stocks trade for well under $1 and quite a few actually trade for fractions of one cent!

Many new businesses get their start: as 'penny stock companies'. To raise capital to get their business off the ground, a new company will offer common shares of stock in their business. Because they are unknown and unproven, they are usually viewed by investors as being very risky. So, their initial offering can literally be valued at well under one penny per share. Hence the moniker: 'penny stock companies'.

In fact, I have owned stock in several companies for which I paid just $0.0001 per share!

Example of a Penny Stock in Play (11/25/11):

China Medical Technologies Inc. (NasdaqGS: CMED )  Last share price $3.79
The company is a China-based medical device company that develops, manufactures and markets advanced, non-invasive, in-vitro diagnostic ("IVD") products to detect and monitor diseases and disorders.

Research for CMED Background and News

Below are some of the resources I will commonly use to research penny stocks in addition to the company's website (click on link above):

4 Stocks To Watch On Novermber 25  (TheHotPennyStocks.com)
4 Chinese Stocks Being Snapped Up By Insiders (SeekingAlpha.com)
CMED Reports F2Q 2011 Financial Results (PR Newswire - Asia - First Call)
CMT's CEO Discusses F2Q 2011 Results (SeekingAlpha.com)
Summary For China Medical Technologies Inc. (Yahoo Finance)
China Medical Technologies News and Video (Morningstar.com)

A couple of interesting 'finds' that I noticed in a cursory review of CMED are:

(Per their website) "China Medical Technologies is managed by an experienced team of professionals and scientists. Our dedicated research and development team is committed to the continuous development of innovative products, both internally and through collaboration with leading research institutions such as the China Academy of Science and Peking University. With an established nationwide sales and customer service network, we are well-positioned to take advantage of opportunities in both domestic and overseas markets. Our innovative products, strict quality control and comprehensive after-sales service have created a solid foundation for our continued success."

In addition:

1.  CMED appears to professionally staffed and managed.
2.  They aren't new kids on the block.
3.  The company is actively acquiring and developing advanced technologies.
4.  They are established with the gov't - critical to do business in China.
5.  Net revenues and income are positive; future outlook also positive.
6.  Recent anaysis showed an oversold position.
7.  Shorts have decreased for this stock - fewer bears, more bulls.
8.  Company insiders are actively buying CMED stock - favorable indicator.
9.  CMED apparenly has solid funding support from several financial institutions.

This information inspires me to look even closer at this stock and is one I am inclined to want to purchase in the near term. 

One of the things I would like to know more about is competition.

What to look for in a penny stock company:

This is very important if you are serious about investing and not just gambling in the stock market.

#1. Proven, experienced management in their field.

#2. A track record of success. There are very few penny stock companies with this under their belts, but if you can find one that is successful - that's a great find!

#3. Profitability. Have they ever made any money? See #2

#4. Product quality. Is what they are selling real? Viable? Sustainable? Is the product unique? What makes it different?

#5. Competition. Who are they up against? What sets your company apart from their competitors?

#6. Funding resources? Very important! Do they simply sell more and more shares to raise capital OR do they have other funding resources?

#7. Have they executed reverse splits in the past? (Click on underlined link for definition.) Have they announced or discussed future reverse splits? This is a major warning signal. I typically consider reverse splits to be "tombstones" and a sign of impending ruin for the company and the investor! (I suggest you learn more about them!) Rarely will you find a reverse split to be beneficial for the company or the average investor.

Things you cannot control when buying penny stocks:

#1. The company you invested in. You are technically an owner and sometimes they will send out proxy vote ballots, but essentially, once you buy stock in a company, you are trusting the company's management team to make good choices.

#2. Market makers. (MM's) These are stock trading entities that can heavily influence the price of a penny stock for their own gain - up or down, (very often, down). Many are legitimate, but others are not. I prefer to call them market "manipulators" or "small company killers".

In my opinion, MM's are the most influential component of the penny stock industry and are the primary reason penny stocks are so volatile.

The problem is that MM's are a necessary evil. Essentially, we couldn't trade penny stocks without them. So you have to hope and pray that you don't have too many crooked ones involved with the stocks that you invest in. 

The SEC (Securities and Exchange Commission), for whatever reason, virtually lets market makers operate with seemingly little oversight - although some recent crackdowns have occurred. There needs to be a lot more regulation on these entities before penny stocks will be considered true "investments" instead of just another form of gambling.

#3. Message boards. These are website forums for specific stocks. Going in, you might think: "hey, this is a great chance to converse with fellow investors!" Guess again! There are many predators on these boards attempting to manipulate investor sentiment and ultimately stock price to their advantage. Truth is not an issue here. It's a free speech vehicle that I strongly suggest you stay away from. I contend that many participants on these boards are market makers preying on gullible investors.

#4. Competition.

#5. The economy. 

Conclusion:

I hope I didn't scare you away from buying penny stocks. That wasn't the intent. But, I have invested in many penny stock companies with great products and potential, only to see them ruined by forces out of their control (and mine).

Again, consider this to be a "buyer beware" discussion. Always do your homework before investing in any stock.

With all that said, I still like the odds of success from buying penny stocks better than buying lottery tickets! Good luck!

AUTHOR'S BIO:

John Hanlin is an Independent Investment Consultant specializing in high yield, low risk investments secured by real estate and is a seasoned investor of over 25 years. John is the owner of the investors' website www.JohnHanlin.com & author of "The 7-Step Retirement Investments Planning Guide" (available at www.LazymanCompany.com)

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