These 13 tips will let you create a list of penny stocks that will help you generate investment profits

Creating a list of penny stocks is easy, but generating a list of penny stocks with an above-average chance of success is much more difficult.

Sometimes you might get lucky for a short time—for example, a decade and a half ago, buyers of Internet start-ups made far more profit than investors who stuck with well-established companies.

The same thing happened when many investors bought low-quality resource stocks in 2007 and 2008, and it has happened in the past in penny stock bubbles.

However, when the bubble bursts, prices of low-quality stocks inevitably come crashing down. After all, it’s much easier to launch a stock promotion than it is to create a successful, lasting business.

Penny stocks tend to be more speculative, and are engaged in such things as finding mineral deposits that can be mined at a profit, commercializing an unproven technology or launching new software.

Not all penny stocks will go bust, but while you’re creating a list of penny stocks that appear to be suitable investments, keep these tips in mind.

How to create a list of penny stocks that will build your portfolio:

1. Only buy penny stocks with money you can afford to lose. Ultimately, Canadian penny stocks should always be a small part of any diversified portfolio.

2. Spread your penny stocks out across different market segments. When making a list of penny stocks, we recommend investing in a range of markets. This includes software, biotech, technology, mineral exploration and so on.

3. Understand the better the promotion, most often, the worse the penny stock. If you let the media hoopla taint your investment decisions, you increase your risk of blundering into a promotional stock rather than a true investment.

4. Beware high-tech penny stock shams: It’s easier to set up a company and sell stock to investors than to perfect a technological breakthrough. Be especially wary when tech penny stocks splurge on elaborate websites and glossy investor brochures.

5. Look for acquisitions. Acquisitions can bring “time-bomb” risk. Companies sometimes grow quickly by buying other companies. But it may also be the case that those selling the companies may simply want to bail out of a losing situation.

6. Diversify your tech penny stocks. The high-tech sector has more than its share of winners and duds. So when making your list of penny stocks, pick 5 to 10 tech penny stocks instead of just one. Gains on your winners should overwhelm any losses you have.

7. Focus on up-and-coming technologies: To do this, you need to know how technology is changing. For instance, the immense popularity of wireless devices, like the iPhone and tablet computers, has stepped up demand for faster, more reliable wireless networks.

8. Buy multi-product companies: Technological advances come in spurts, and they leapfrog each other. Focus on tech penny stocks that have some existing or soon-to-be-released products, and avoid one-hit wonders.

9. Look for earnings: A perpetual money loser will eventually go broke, no matter how impressive its technology. But if it makes even a little money, it can stay in business and perhaps reap the bonanza of a new product.

10. Be especially careful with penny mining stocks before investing. It is sometimes said that a single drill hole has a 1-in-1,000 chance of turning up an “anomaly,” or a drill result that could be a marker for a mineral deposit. However, the odds against finding a mine on any one anomaly are also about 1,000-to-1. So, the odds that a particular drill hole will lead to the discovery of a valuable mineral deposit are about a million-to-1. That’s why we never recommend Canadian penny mining stocks that have much or all of their value riding on a single drill hole. Instead, we want to see a series of promising drilling results, along with other encouraging development work.

11. Avoid Canadian penny mining stocks that trade at unsustainably high prices because of broker hype or investor mania about the underlying commodity (such as gold). Instead, we focus on reasonably priced Canadian penny mining stocks with favourable geology.

12. Be wary of penny stock promotions that involve the announcement of deals with major, household name companies. When they get a deal with a major, promoters go to great lengths to make it seem bigger than it is. Instead of announcing that the big company has invested, say, $50,000, penny stock promoters may issue a press release that says the two companies have entered into a “multi-stage development plan”. In fact, this is when it’s a good time to sell, not buy.

13.  Apply our sell-half rule. Selling half your holdings after you double your earnings is a good strategy for any high-risk investment, but especially so for penny stocks. This can give you a clearer perspective on what to do with the other half of your investment. After all, if you are too slow to sell speculative stuff, your profits and even your principal can evaporate all too quickly.

If you lose money in penny stocks, you may think your main mistake was bad timing. That’s a misconception. You can get lucky in making a list of penny stocks, just as in lotteries. But if you play long enough, the “house odds” eventually triumph over any run of luck. In penny stocks or games of chance, the odds are against you. The longer or more often you play, the likelier you are to lose.

Have you had any luck making a list of penny stocks? Care to share your results? Let us know how you fared in the comment section.