Some mine stocks are major companies that have been producing for years. Penny stocks, on the other hand, may sound like great investments but are very speculative and risky.

We continue to recommend that you cut your risk in the more volatile resource sector by investing mainly in stocks of profitable, well-established companies. For the mining stock component of this segment, the focus should be on firms with positive cash flow and high-quality reserves. Resource stocks overall (and this includes oil and gas, of course) should make up only a limited portion of a Successful Investor portfolio.

Investing in the right mine stock can lead to a big payday when you make the right choice. But it is important to follow these tips in order to increase your chances of success.

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Mine stocks can generally be broken down into two categories: majors and juniors

Majors are typically mining companies that have been in the mining business for many years, and more often than not they operate producing mines on a global scale. Successful majors have proven methods for exploration and mining, and have consistent output, and cash flow, year over year. On the other hand, junior mining companies typically have negative cash flow since they’re spending money in hopes of finding a mineable deposit.

A penny mine stock is one of the riskiest investments around

Penny mining stocks are some of the riskiest stocks Successful Investors can can buy. These companies aim to find mineral deposits with mine-making potential—but such finds are exceedingly rare. Because of this, it’s even more important to try to maximize investment quality in penny mines.

For example, we automatically rule out investing in penny mines that promote themselves too aggressively or do so misleadingly. The mine-finding effort is more likely to succeed if the managers focus on finding a mine rather than hyping their stock.

Avoid flow-through funds when making mine stock picks

Flow-through limited partnerships are tax shelters that mainly invest in the flow-through shares issued by junior mining and oil companies. These companies spend the proceeds from the shares they sell on mineral exploration and development, an activity that qualifies for certain tax credits and tax deferrals. These tax benefits “flow through” to investors in the fund. In general, to take advantage of these benefits, investors need to hold the funds for a fixed period, usually 18 months to two years.

Investors buying into flow-through limited partnerships are typically able to deduct 100% or more of their investment against income by the end of the second year. This leaves the investor with a cost base on the units of zero. When you subsequently redeem or sell the limited partnership units, you pay capital gains on the entire balance of the sale. That’s advantageous for investors, because capital gains are the lowest taxed of various income streams that investors can receive.

However, the problem with these tax shelters is that they may persuade you to make a risky investment you wouldn’t otherwise make. Moreover, a portion of the benefits are set aside for brokers and the partnership’s organizers. What’s left may not be enough to pay you for taking on the extra risk.

Keep in mind that most flow-through issuers are junior companies that are short on financing, or don’t have enough income to make full use of the tax benefits associated with their exploration. That’s why they sell these benefits to investors.

One big drawback in flow-through limited partnerships is that almost all of the flow-through mining and energy stocks they invest in are highly speculative. The partnerships are also usually in a hurry to invest their money to pass the tax deductions on to their investors as quickly as possible. That can lead to some hasty stock selections.

Rather than invest in flow-through entities, we think you are much better off keeping things simple and investing in strong mine stocks.

There are some key ways to minimize the risks of investing in a penny mine stock

The best way to make money with penny stocks is to look for these criteria:

If you’re investing in penny mining stocks, look for experienced management with a proven ability to develop and finance a mine.

Also, when investing in penny mining stocks, look at environmental constraints in places where junior mines are exploring for minerals. In Europe and certain parts of the U.S., junior mines need a particularly rich find to justify the costs of overcoming environmentalists’ objections.

And when we recommend juniors that are exploring for minerals, we prefer those that operate in an area whose geology is similar to that of nearby producing mines.

When we recommend mine stocks, we want to see positive cash flow, preferably even when commodity prices are low. Even better, we like to see mining companies that have cash flow from an existing mine that is sufficient to cover, or at least contribute to, the cost of developing a second mine.

We avoid mining stocks that trade at unsustainably high prices because of broker hype or investor mania. Instead, we focus on reasonably priced mining stocks with realistic prospects.

Ultimately, penny mines should always be a very small part of any diversified Successful Investor portfolio. You should only buy the most speculative of them with money you can afford to lose.

Junior mining stocks can be volatile, which for some investors is part of the appeal. Have you been lured by the same?

With such a large associated risk, why do you think people invest in penny mine stocks?