It’s imperative to follow our guidelines to pick the best TSX penny stocks

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.

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

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TSX penny stocks: Main factors we look at when picking penny stocks

• 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 low debt. Even better, we like to see a major partner who can finance a 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 their current share price and avoid collapse.

Penny stocks and long-term return

Although the price may seem right, the average penny offers a poor long-term return. After all, it’s hard to create a successful business. It’s much easier and cheaper to set up a company and sell stock to the public. That’s why bad penny stocks always outnumber good ones.

Disappointed penny-stock buyers may next latch on to the P/E ratio—the ratio of a stock’s per-share price to its earnings-per-share—as a tool to find stocks to buy..

Some decide they will only buy stocks with a P/E of 10.0 or less, and that they’ll sell if the P/E goes above 20.0. Compared to zeroing in on penny stocks, this may cut your losses, or even yield a little profit. But that hardly qualifies as successful investing.

The odds against success are high with TSX penny stocks

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.

When penny stock promoters manage to make a deal with a major firm, they often go to great lengths to make it seem bigger than it is. It pays to remember that a big company doesn’t go into a situation like this the same way you do. The big company will always reserve the right to drop out and cut its losses. In most cases, it will exercise that right.

Instead of trying to predict the future of an investment, which is nearly impossible in penny stocks, diversify across different market segments, like software, biotech, technology, mineral exploration and so on.

If you’re buying penny stocks that are perpetual money losers, they will eventually go broke, no matter how impressive their technology. But if a stock makes even a little money, it can stay in business and perhaps reap the bonanza of a new product. Diversifying helps find these stocks, and while you should only invest in speculative penny stocks with money you’re willing to lose, you may have a greater chance at winning.

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.

Make TSX penny stocks a small portion of your portfolio, if that

Ultimately, Canadian penny stocks should always be a small part of any diversified portfolio. You should only buy the most speculative of them with money you can afford to lose.

Are you currently holding TSX penny stocks? How have they performed for you? Share your thoughts with us in the comments.