Sharing our proven guidelines for successfully picking penny stocks to recommend to our clients and in our newsletters

Penny stocks are riskier, more speculative investments, most often included in the portfolios of aggressive investors. Penny stocks are engaged in such activities as finding mineral deposits that can be mined at a profit,commercializing an unproven technology or launching new software applications.

We get requests daily from newsletter subscribers 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.

When looking at those penny stocks, or picking penny stocks for our investment newsletters, we examine them all very closely to see if any can be considered as worthy of investment.

That’s because of the many safeguards we apply to cut your risk and improve investment quality. It may seem contradictory to use the terms “investment quality” and “penny stocks” in the same sentence. However, there are even wider disparities in the investment quality of penny stocks than in better-established companies.

Here are the main factors we look at when picking penny stocks:

1. We insist on political stability. Exploration is risky enough without the threat of expropriation or onerous taxes.
2. 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.
3. We like to see a strong balance sheet with low debt. Even better, we like to see a major partner who can finance the mine, software and so on to production.
4. We want to see experienced management with proven ability to develop and finance a their beginning business.
5. We avoid stocks trading over-the-counter where regulatory reporting and so on is lax.
6. We avoid stocks trading at unsustainably high prices due to broker hype or investor mania.
7. 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.

What you should know before picking penny stocks for an aggressive portfolio

1. Low-quality 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.

2. The longer you play, the likelier you are to lose.

If you lose money in speculative 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. You can get lucky in 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.

Because buying penny stocks is often pure speculation, it can pay off extremely well when it succeeds, of course. But, in addition to the business odds against success, it’s much easier to launch and promote a stock than it is to find a mine, for example, or invent a new battery.

That’s why penny stocks are so common, even though profit-making companies are rare. It’s also why most such stocks will fail, and why they should make up only a very small part of your portfolio.

How to begin picking penny stocks

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

1. Pick penny stocks with money you can afford to lose. Ultimately, Canadian penny stocks should always be a small part of any diversified portfolio.
2. Pick penny stocks in 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. Pick penny stocks that have low acquisition risk. 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.
4. Pick several 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.
5. Pick penny stocks with 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.
6. Pick penny stocks that are 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.
7. Pick penny stocks with 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.

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