Buying penny stocks is a gamble—but here are 7 tips to help tilt the odds in your favour.

Some investors look to penny stocks as a quick way to boost their investment gains. But while buying penny stocks can lead to a big payday when you make the right choice, the odds against your 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. Even if you want to take on that risk, you need to be extra careful about the penny stocks you do buy.

Never forget that it’s much easier to launch and promote a stock than it is to start a successful business. So penny stocks attract more than their share of unscrupulous operators and stock promoters.

Be Wary Of Promotional Publicity

Penny stock promoters love to make “deals” with major, household-name companies. They’re convinced that the public is more interested in penny stocks that have some connection with names they recognize. However:

1. Major company involvement is frequently exaggerated: When promoters manage to make a deal with a major firm, they often go to great lengths to make it seem bigger than it is. Instead of announcing that the big company has invested, say, $50,000, a stock promoter may issue a press release saying the two companies have entered into a “multi-stage development plan.” The release may say the major company has agreed to spend “up to $10 million” or some other exalted figure. It will usually provide a toll-free number or web address for investors to order or download the glossy brochures.
2. Big companies have far more bargaining power than individual investors: It pays to remember that a big company doesn’t go into a situation like this the same way you do. If the big company agrees to spend $50,000 to study the mining property, new technology or pioneering program, it will also insist on a series of options that let it invest ever-larger sums on favourable terms. But the big company will always reserve the right to drop out and cut its losses. In most cases, it will exercise that right.

A major company will gladly spend $50,000 one hundred times, and lose every penny of it—a total outlay of $5 million—if this means it will get a chance to develop the one rare project that’s ultimately worth an investment of, say, $500 million. If it waits till the property, technology or program has proven itself, development rights will be far more costly. So it gets in early by investing what are really just token amounts of money for a major firm. That’s why big-company involvement by itself is never a good reason for buying penny stocks.

7 more keys to smart investing in penny stocks

In addition to avoiding Canadian penny stocks that promote themselves too aggressively (or do so misleadingly) here are 7 more things we look for when we analyze penny stocks for Stock Pickers Digest, our newsletter for aggressive investing.

1. Make penny stocks the smallest portion of your portfolio.
2. If investing in penny mining stocks, look for experienced management with a proven ability to develop and finance a mine.
3. Also when investing in penny mining stocks, look at environmental constraints in places where junior mines are exploring 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.
4. When we recommend junior miners that explore for minerals, we prefer those that operate in an area whose geology is similar to that of nearby producing mines.
5. We think you should avoid penny stocks that trade over the counter, where such things as regulatory reporting are lax.
6. If you’re buying penny stocks that are perpetual money losers, they 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.
7. 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.

If you are looking to buy penny stocks or other aggressive investments, you really should have a subscription to Stock Pickers Digest. You can save $100.00 off the regular rate with our introductory subscription (exclusively for new subscribers). The latest issue gives you our up to date analysis—and clear buy/sell/hold advice—on 20 stocks that may be suitable for the part of your portfolio you devote to aggressive investing.

Are you considering buying penny stocks? Have bought some in the past? Have they been winners or losers? Share your experience with us in the comments.