My definition of a ‘penny stock’ is a stock which trades under $5 and has a market cap of less than $250 million.
If your a member of Pinnacle Digest, chances are you have the penny stock itch we’ve all grown to love - and for good reason. What other market, business venture or investment for that matter, can you double your return on investment overnight? Penny stocks can literally change people’s lives overnight if they know how to find the winners. These under-appreciated but sometimes overhyped stocks are also huge gambles. I’ve seen millionaires made from these obscure investments (several actually) and I’ve also seen the financial well being of industry peers destroyed from an over allocation in penny stocks.
It is an investment arena of extremes, with many variables that determine how successful your investment will be; some variables in which no one, not even the company’s management, has control over.
Because of all the variables, the inherent risk and the misconceptions involved with penny stocks, I want to share with everyone a list of Do’s and Don’ts for these investments.
- Never, and I mean never, invest more than you can afford to lose. It is an expression that has been used thousands of times, and for good reason. If you invest more than you can afford to lose, when the roads gets bumpy you won’t think with a clear head and impulse (and emotional) decisions will be made. These rarely work out in your favor.
- Never invest solely on the basis of a stock tip. I don’t care if it’s from a friend, work colleague or your own mother. The people giving you these ‘stock tips’ likely have your best interest at heart, but that doesn’t mean they’re right.
- Never invest based on what you read on an internet message board. Although internet message boards can be helpful, posters can have ulterior motives you know nothing about. And they may not even have any real knowledge of what they speak about.
- Never invest based solely on what you read in a newsletter. I know what your thinking so let me stop you right there. Yes, Pinnacle Digest publishes a newsletter which sometimes features specific stocks, but that doesn’t mean it should be your only source of information for that stock. Conduct your own due diligence. Obviously I believe in the concept behind newsletters and know Pinnacle Digest runs a damn good newsletter (as do many others - Jim Dines, Peter Grandich, James West to name a few), but consider it an information source, not investment advice or the ‘be all end all’. No one is right 100% of the time and not doing your own due diligence is just sloppy.
- I strongly believe in never chasing stocks. If a stock has seen its share price increase more than 50% along with its volume (increase of at least 4 times 50 day average volume), accept the fact that you missed the boat. There’s nothing worse than chasing a stock up to a 52 week high, only to see it lose 80% of what it gained. Penny stocks are meant to give investors a chance at getting in on an investment in the early stages. Don’t chase the hype. Be a leader and get in on opportunities before everyone else.
- This last one varies depending on your risk tolerance and the size of your portfolio. Never should penny stocks (even if you have massive risk tolerance like myself) consume more than 25% of your portfolio. Ultra conservatives will tell you penny stocks and your portfolio should never mix, but inevitably it comes down to your personal financial position and risk tolerance. If your losing sleep over an investment, if your mood changes when your investments are down, penny stocks aren’t for you. They come with extreme price swings and not everyone can stomach that.
- If you’re thinking about buying a stock after you’ve conducted adequate due diligence, contact the company via email or phone and have them answer questions for you. Think of it like you are investing in a business - because you are. You wouldn’t buy a McDonald’s franchise without asking the company questions, conducting surveys, analyzing location demographics etc. Same goes for investing in stocks. When you buy a stock, you are a part owner in that company and its your right to be able to contact company management or investor relations and get the answers to your questions (within reason of course). If you have conducted your due diligence and don’t have any questions, well then I’d say you didn’t do proper due diligence. I view myself as a great ‘tire kicker’ and never have I conducted due diligence and not had questions for the company. Don’t be scared to pick up a phone or type an email, company employees love speaking to investors - that’s their job. If you try contacting the company and receive no response, don’t buy their stock as they lack professionalism and don’t deserve your hard earned money.
- Accept the fact that when investing in penny stocks you could ( and in many cases will) see the stock drop and rise as much as 50% (or more) from your purchase price. If you can’t handle volatility, these aren’t for you.
- Take profits! Contrary to what you may read on a message board when a stock is rising, share prices don’t actually end up making it to the moon. I’ve taken profits too early in the past, I’ve held too long and missed the peak, but I’ve never been mad at myself for making a profit - nor should you.
- Contact a broker if you have one. Seek professional advice on what is a reasonable amount to invest in penny stocks or a particular penny stock given your risk tolerance. They are expected to follow KYC (know your client) standards and should have an idea. If they don’t, get a new broker.
- Spread your risk money around. If you have $10,000 you feel comfortable investing in penny stocks, don’t throw all your cash at just one. If I was using the $10,000 allocation example, I’d put $2500 in four different penny stocks I liked. If I bought 4 stocks and lost 25% on three of them, but made 200% on the fourth, I’m laughing. With proper due diligence this is not an unlikely scenario at all. Penny stocks are about hitting home runs, not singles. If you stay in the game long enough, you’ll witness your fair share of home runs.
- Get ahead of trends. For example: If your research shows that the price of uranium is due for a significant spike, junior uranium companies could be your best bet. Juniors commodity plays often have much more leverage to the price swing than a major. This is where you can get 2 or 3 multiples on the price movement of the actual commodity - a big reason I love junior resource stocks so much.
- Find comparables! This is so important in determining fair value for a penny stock. For more information on this read my blog ‘The Importance of Finding Comparables for Junior Mining Stocks’.
- Always, always review the track record of the company’s management team. Management is the single most valuable asset a small company has. These are the people you are investing in and putting your trust in. In an essence, these people are your partners.
- Finally, have fun! penny stocks are all about excitement and the thrill of the find. Enjoy investing in start-ups and take great pride when you find a winner. It’s all about the journey after all.
P.S. I hope all of you saw our Super Bowl prediction in last weekend’s newsletter. Although our score was slightly off, we correctly predicted the winner and total turnovers in the game! One of my colleagues, who for his sake will remain nameless, was trying to tell me that getting rid of Brett Favre was the worst move the Packers ever made...
This article represents solely the opinions of Aaron Hoddinott and not of PinnacleDigest.com nor Maximus Strategic Consulting Inc. Aaron Hoddinott is not an investment advisor and any reference to specific securities in the list referred to in the article does not constitute a recommendation thereof. Readers are encouraged to consult their investment advisors prior to making any investment decisions. The information is of an impersonal nature and should not be construed as individualized advice or investment recommendations.