Learning how to find good penny stocks using our pointers will help you avoid the worst of them, while at the same time spotting the best of them

Penny stocks that appear promising may start out with a brilliant idea or a plan to get involved in a high-profile or fast-growing business area. They may enjoy an initial burst of sales or even earnings. But most just can’t keep up the momentum. They never reach the critical mass they need to achieve consistent profitability.

We consider the majority of penny stocks to be gambles, but we do have some tips on how to find the few good penny stocks for making money if you decide to invest in them.

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Learn how to find good penny stocks by looking for these main factors:

• We insist on political stability. For example, mineral exploration is risky enough without the threat of expropriation or onerous taxes.
• We look for well-financed penny stocks with no immediate need to sell shares at low prices, since that would dilute the interests of existing investors.
• We like to see a strong balance sheet with manageable debt. Even better, we like to see a major partner who can finance the mine, software and so on to production.
• We want to see experienced management with proven ability to develop and finance a new business.
• We avoid stocks trading over-the-counter where regulatory reporting and so on is lax.
• We avoid stocks trading at unsustainably high prices due to broker hype or investor mania.
• We compare the market cap of the stock with the estimated value of its mineral reserves, future product sales and so on. Some pennies need to find a mine, or successfully market a lot of their software, or other products, to justify the current share price and avoid collapse.

How to find good penny stocks: Recognize that pharmaceutical penny stocks are more speculative than many investors realize

Some pharmaceutical companies can be riskier than most investors realize. They need a continuing flow of successful new products to maintain their earnings. They face increasing litigation and aggressive competition from generics as drugs come off patent. Unlike tech stocks, they have formidable regulatory burdens, and unlike other manufacturing stocks such as, say, auto companies, they do not benefit from customer loyalty.

Pharmaceutical or biotech penny stocks are even more speculative, and come with a greater variety of problems than many other penny stocks. Successful investors should be aware of the risks.

As mentioned, drug stocks are riskier than investors realize. The cost of developing a new drug is huge, and the payoff, if any, is uncertain. That’s even more so with pharmaceutical or biotech penny stocks, which typically have just one or two drugs under development—and in very early stages with eventual commercialization very unlikely.

Use our “sell-half” rule with penny stocks to boost your profits over time

Knowing when to sell a stock is one of the most important factors in successful investing—it’s almost as important as knowing when not to sell. That’s why we advise investors to follow a key rule when it comes to rising stocks.

Selling half of your hot stocks that surge helps you guard your profits. But apply this rule to more aggressive stocks, and not to the well-established stocks that may surprise you by going a lot higher in the long run.

Whether your approach to investing is conservative or aggressive, the quality of your investments matters much more than your skill at selling.

However, you should be quicker to sell aggressive stocks than conservative ones. With stocks we rate as “Speculative” or “Start-up,” it pays to apply the sell-half rule.

Use caution when you aim for penny stock gainers: the longer you play, the likelier you are to lose

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, as mentioned, we think you should apply our sell-half rule.

Use our three-part Successful Investor approach to make the process of learning how to find good penny stocks easier

It’s possible to make money from penny stocks, but only if you follow our tips above—and utilize our Successful Investor approach for the bulk of your portfolio

Ultimately, penny stocks could make up a small part of any diversified portfolio. But you should only buy the most speculative of them with money you can afford to lose.

Meanwhile, remember to spread your portfolio out across most if not all of the five main economic sectors: Resources; Manufacturing; Finance; Utilities; and Consumer. By diversifying across the sectors, you also increase your chances of stumbling upon a market superstar—a stock that does two to three or more times better than the market average.

Our three-pronged Successful Investor philosophy takes that general description a little further. In addition to spreading your investment money out across most if not all of the five economic sectors, we advise you to invest mainly in well-established companies, and focus on companies that are outside the broker/media limelight.

Some of the biggest stock scams in recent history involve penny stocks. Does this make you feel more wary about investing in pennies or not?

Do you have any tips to share that have helped you find good penny stocks?