The best penny stocks allow for (risky) diversification in your portfolio

One big trouble with penny stocks is that even the best penny stocks don’t usually make you enough money to make up for your losses on bad penny stocks along the way.

Sure, penny stocks do sometimes pay off, but there are many pitfalls to avoid. As you’ve heard us say often, a lot of penny stocks are little more than very well executed marketing campaigns.

You can’t trust many penny stock promotions, because some penny stock promoters will do anything in their power to get their penny stock noticed. These can include extensive marketing campaigns with emails, TV interviews, podcasts, newsletters and often paid sponsorships—anything that will get you to invest.

We get requests daily from Inner Circle members who are asking whether or not to invest in this penny stock or that penny stock, which we answer one by one in the Q&A section of our membership website.

If you want to invest in penny stocks, you can select the best penny stocks by following our seven tips listed below.

7 tips for making money with the best penny stocks

Use the tips below when investing in penny stocks if you want to diversify your portfolio by putting a small amount into pennies, and avoid the biggest risks.

1. Look for well-financed companies: To profit in penny stocks, you should look for well-financed companies with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests.
2. Look for a strong balance sheet: High-quality penny stocks should have strong balance sheets with low debt. It’s even better if they have a major partner who can finance the penny stock’s product to market or its mine into production.
3. Look for strong management: Look for an experienced management team with a proven ability to develop and finance a mine, product or service.
4. Look for stocks trading on an exchange: We think you should avoid stocks trading “over-the-counter”, where such things as regulatory reporting are lax. Stick to penny-stocks trading on well-regulated exchanges like the Toronto and New York stock exchanges.
5. Look past the hype: We also recommend avoiding stocks that are trading at unsustainably high prices as a result of broker hype or investor mania.
6. Look for reasonable share prices: Compare the market caps (the total dollar value of all of a company’s outstanding shares) of the stocks with the estimated value of their assets or future earnings streams. Only a few penny-stocks will successfully launch a product with enough success to justify their current share price and avoid collapse.
7. Look for a focused company: Above all, you should automatically rule out investing in companies that promote themselves too aggressively, or do so misleadingly. Success is more likely if the managers focus on developing a saleable product or service, rather than hyping their story.

Low-quality Canadian penny stocks are quick to fall when a bubble bursts

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. When the bubble bursts, however, 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. Others focus on commercializing an unproven technology or launching new software.

The longer you play, the likelier you are to lose

If you lose money in speculative pennies or other low-quality stocks (or ETFs that invest in low-quality stocks), you may think your main mistake was bad timing. That’s a misconception. Almost all penny stocks rely on luck to become wildly profitable. 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. So, time works against you. The longer or more often you play, the likelier you are to lose.

That’s also why we think you should apply our sell-half rule.

Selling half your holdings after you double your profits is a good strategy for any high-risk investment, but especially so for penny stocks.

Do you have any holdings you’d consider to be the best penny stocks? How have they performed for you and how long have you had them? Share your story in the comments.