Discovering top penny shares to invest in can lead to a big pay day if you choose correctly. Here are the factors to watch for—or avoid—when analyzing pennies

Ultimately, penny shares to invest in should make up only a small part of most investor portfolios. And you should only buy the most speculative of them with money you can afford to lose.

It’s possible to make money from penny stocks, but only if you follow our tips below—and at the same time protect your capital by using our Successful Investor approach for the bulk of your portfolio.

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Approach even the best penny shares to invest in with caution

When you buy penny stocks you could have a big pay day if you make the right choice. But the odds against success are high. Penny stocks are almost always involved in riskier ventures, such as finding mineral deposits that can be mined at a profit, commercializing unproven technologies or launching new software.

In general, penny stocks have lower trading volumes or liquidity, and this lack of liquidity means it may be more difficult to sell a stock when you want to. They also suffer from large price fluctuations, so any bit of news will cause a penny stock’s price to rise or fall.

We think you should also 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.

Here’s how to spot the best mining penny shares to invest in—and the ones to avoid

We generally stay away from mining companies that operate in insecure and politically unstable regions. We also stay away from those in countries with little respect for property rights and the rule of law. That’s because mining is vulnerable to political instability.

We look at environmental constraints where the junior mines are looking 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.

When we recommend junior mines that only explore for minerals, we prefer those that operate in an area with geology that is similar to that of nearby producing mines.

We want to see mining firms with experienced management that has a proven ability to develop and finance similar projects by working with other junior-mining companies. Even better, we like to see mining companies that have cash flow from an existing mine that is sufficient for, or at least contributes to, the cost of developing a second mine.

More factors to watch for when looking for penny shares to invest in

 Often, using the terms “investment quality” and “penny stocks” in the same sentence is contradictory. There are, however, ways to distinguish those few penny stocks of better quality when seeking to invest in this high-risk area. Here are seven general ways you can cut your risk: 

• Look for well-financed companies with no immediate need to sell shares at low prices because selling would dilute existing investors’ interests.
• Seek companies with a strong balance sheet and low debt. It’s even better if there is a major partner who is financing the mine, product or production to commercialization.
• Find companies with experienced management teams with the proven ability to develop the mine, product or service.
• Avoid the over-the-counter market where regulatory reporting is lax and the market for buying and selling is usually thin. Legitimate companies worth your investment are seeking to leave the over-the-counter market as soon as possible.
• Avoid stocks trading at unsustainably high levels as a result of investor mania or broker hype.
• Penny stocks are susceptible to extreme highs and lows that can be influenced by such things as a major investor selling their stock (which could easily destabilize the financing of the company) or a positive news report (which, in the case of penny stocks, could send the price soaring, but for all the wrong reasons).
• Compare the market cap of the stock with the estimated future value of their assets or earning stream. Sometimes, companies need to find the money to quickly acquire a mine or launch a project to justify their current share price.
• Rule out investing in companies that are highly aggressive or misleading when promoting themselves. Instead, focus on companies that are developing a mine or launching their saleable product or service instead of selling stock or telling their story. They are more likely to be successful.

Use our three-part Successful Investor approach for your overall portfolio

1. Invest mainly in well-established, mostly dividend-paying companies;
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities);
3. Downplay or avoid stocks in the broker/media limelight.

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