how to evaluate a penny stock

1. Price-to-Sales (P/S) By dividing the current share price of the penny stock by the company's annual sales, you will see if the investment is over or undervalued.
2. Current Ratio. This one is of monumental importance with penny stock companies. ...
3. Quick Ratio. While the current ratio takes all assets into account, the quick ratio only considers assets that can quickly and easily be used.
4. Operating Cash Flow. This considers cash flow from operations, then divides it by current liabilities. ...
5. Inventory Turnover. This shows how effective the business is in producing and selling products. ...
6. Debt Ratio. This is a simple one, but it is an important one. Just divide total liabilities by total assets. ...

Full Answer

How to pick the best penny stocks?

Look for a minimum daily volume of 100,000 traded shares. Pull up the price chart and look for increased volume combined with a rising stock price indicating an …

How to invest in penny stocks for beginners?

 · Penny stocks, those with a price of less than five dollars per share, are likely to be companies that have fallen on hard times. Investors are signaling, through the price of the shares, that they have doubts the company will survive. If they did not have such doubts, the price of the stock would be higher.

How do you pick penny stocks?

 · Ratios that don't rely on earnings numbers can be helpful for evaluating penny stocks, which are shares in smaller, newer businesses. In particular, penny stock investors should look at the price-to-sales ratio, current ratio, quick ratio, and debt ratio, along with operating cash flow and inventory turnover. Finding the Right Ratios

How to pick winning penny stocks?

 · How to Pick Penny Stocks? Understand the Valuation and Price of Shares. The price of the stock will tell you about the company’s current value in... Practice Day Trading with Paper Trading. Before moving to penny stocks, get some actual practice to know more about the... Understand Your Investment ...

How do you know if a penny stock is good?

Penny stocks have the following characteristics: Low cost and low volume of trade, Unpredictable results, Smaller business, It is speculative, Market capitalization is low, Factor of high risk, erratic Price fluctuations.

Can you get rich from penny stocks?

Can you make money on penny stocks? It is possible to make money with penny stocks. Then again, it's technically possible to make money with any type of stock. Successful investors usually focus on the potential for their stock picks, regardless of price, to gain value over the long term.

How do you know when a penny stock will go up?

Look for an unexpected rise in the volume of shares traded as a possible hint that good news is imminent. Strong volume and a rise in price can indicate the stock is ready to break out into a higher trading range.

Was Amazon a penny stock?

Amazon (NASDAQ: AMZN) Amazon is another all-time regret for many traders. At its IPO in 1997, it traded under $2 a share. It graduated from its penny stock designation in 1998. It last dipped below $100 in 2009.

Was Apple a penny stock?

Apple Inc. While, Apple never really did trade as a penny stock, however, throughout 2002 and 2003, shares of Apple could have been picked up for well under $8 per share (split-adjusted). This was a few years after the iPod was released and before the iPhone and iPads were released.

How do you pick penny stocks before they explode?

How to Pick a Potential Penny Stock Winner Pre-SpikeWhere to Look for Penny Stocks.Share Price and Valuation.Beware Dilution.Rule #1 — Look For Stocks That Are Already Spiking.Rule #2 — Look for Potential Breakouts That Are Reaching New Highs.Rule #3 — Bet on Price Action.Rule #4 — Do Your Research.More items...

How do you tell if a stock is going to go up?

We want to know if, from the current price levels, a stock will go up or down. The best indicator of this is stock's fair price. When fair price of a stock is below its current price, the stock has good possibility to go up in times to come.

What causes penny stocks to spike?

Key Takeaways Because penny stocks have fewer shareholders, it is easy for buying and selling activity to become imbalanced. This causes prices to fluctuate. Corporate growth on more than one front, such as rising revenues and an expanded workforce, often leads to an increase in share price.

What do you look for when looking at penny stocks?

When most retail traders look at a penny stock, they often ignore underlying fundamentals, such as the number of shares outstanding. As is the case with all investing, it's important to examine a company’s underlying fundamentals and overlay this information with details, such as how badly the shares are being diluted through the use of stock splits, stock options and issuing new shares to raise capital.

What is penny stock?

Penny stocks, as the name suggests, are stocks of those companies that trade with a low share price, often for less than $1. Given such a low share price, there is an understandable draw for retail investors who dream of buying 10-cent shares and seeing them rise to ten or more times that sum. But before dabbling in penny stocks, an investor should ...

Does dilution hurt penny stocks?

Share dilution hurts existing shareholders and it's particularly common with penny stocks. Keeping an eye on the share structure and other fundamental factors mentioned above will help investors find winners.

Why is it important to find a company that has a strong grasp on its share structure?

When trading penny stocks, it's important to find a company that has a strong grasp on its share structure because consistent dilution erodes the value of the shares held by existing owners.

What would happen if Company A issued 110,000,000 shares?

In this case, the underlying business hasn’t changed. But the number of shares has, causing the share price to drop.

What is the factor to be conscious of when trading penny stocks?

Another factor to be conscious of when trading penny stocks is dilution . The number of shares outstanding can often balloon out of control through the use of tools such as employee stock options, share issuance in order to raise capital and stock splits.

What are the biggest mistakes that retail investors make?

Share Price and Valuation. One of the biggest mistakes that retail investors make is that they view penny stocks as being affordable. There is a sense that one is getting a better bang for their buck when they buy thousands of shares rather than a couple of a company with a higher share price.

What is penny stock?

Penny stocks are stocks that are usually priced under one dollar a share and are thinly traded, which can make them a challenge to research . Penny stocks don't have the same reporting requirements as stocks listed on the major exchanges, nor do they have the same regulatory oversight.

How volatile are penny stocks?

Penny stocks are notoriously volatile, and daily price swings of 20 percent or more are common. Conducting a thorough analysis can help a trader find a penny stock company worth the investment. Select a sector or industry that’s in an uptrend across the market.

Can stock prices change?

Stock prices and volume can change based on news announcements. Determine if a fundamental change in the company accounts for a sell-off before closing your position.

How to find penny stocks?

There are also great stock screeners online for free through sites such as Google, and most major financial portals. If you want stocks trading at $3 or less in the precious metals industry, you can set the screener to return only those results. This can then act as a great shortlist, through which you can find the penny stocks you want to trade. Many online brokerage platforms also enable users to screen stocks by industry and by price from low to high. Through this filtering and sorting, you can find the stocks in the price range you seek and you conduct more thorough research.

What does "buy what you know" mean in penny stocks?

When it comes to penny stocks, the change from current fad to former fad usually results in the shares of all the penny stocks in that hot industry collapsing significantly. The old expression goes, "buy what you know.". If you are a medical scientist, you will have an advantage when trading biotech stocks.

How to avoid big mistakes in trading?

You can avoid big mistakes by learning how to trade with the risk-free, no-money-required method of buying and selling low-priced shares, known as "paper trading." All you need are a pen and a piece of paper to keep track of imaginary trades in real stocks, using a portfolio of imaginary money.

How to find stocks yourself?

You can find many stocks yourself by using a stock screener such as FinViz.com (Financial Visibility). This is an example of a great online tool for uncovering potential investments, which you will better understand how to use the more you try it out, the more you paper trade, and the more you learn about investing.

What is the best way to trade penny stocks?

Paper trading will probably be the best thing you will ever do in terms of penny stocks. By tracking imaginary profits and losses, you can make a more knowledgeable jump into real money. That will also help you learn all the relevant penny stock lingo, learn from your mistakes, and appreciate all the things to look for when you try to find the next penny stock winners.

What does it mean when a penny stock is under 5?

Penny stocks, those with a price of less than five dollars per share, are likely to be companies that have fallen on hard times. Investors are signaling, through the price of the shares, that they have doubts the company will survive. If they did not have such doubts, the price of the stock would be higher. But if these companies have stocks listed on major U.S. exchanges, it suggests that these firms have passed some level of vetting and have produced sufficient financial disclosures to be allowed to list on such exchanges. This status signals that they have a healthier standing, some access to resources, and market knowledge, and that they have a chance to turn their business prospects around. Successful penny stock investors know that what they need to look for are signs of a business turnaround.

Is it bad to walk away from penny stocks?

Be honest with yourself, and do not feel bad about walking away from the entire concept. In general, this is often the best choice, because most situations involving penny stocks result in many investors taking losses. 2. The good news is that it is easy to avoid the catastrophic losses some investors make in trading penny stocks.

How to invest in penny stocks?

When it comes to investing in penny stocks, tread with caution. In most cases, these companies are small-cap stocks and are susceptible to major volatility. If you feel like you understand the risks and are ready to proceed, the first step is to find a broker, fund an account, and then find a suitable trading candidate. Stock screeners are probably your best bet in narrowing down the universe of stocks so that you can find one that meets your trading style and risk tolerance.

What is penny stock?

The Securities and Exchange Commission (SEC) defines a "penny stock" as a security issued by a small-cap or micro-cap company that trades at less than $5 per share (though some experts choose to adopt a lower cut-off value of $1 per share). 1  They often have little or no financial history, ...

What is the first step to take when investing in penny stocks?

If you feel like you understand the risks and are ready to proceed, the first step is to find a broker, fund an account and then find a suitable trading candidate.

Is liquidity a concern?

Therefore, liquidity is a serious concern: It's not uncommon for retail investors to get stuck in a position for several days or weeks until there is enough supply or demand to enter or exit, experiencing serious price fluctuations along the way.

Is penny stock a risk?

When it comes to trading penny stocks, it's extremely important to understand the risks involved. Since most institutional investors, such as mutual funds, index funds and money managers are prevented by charter from trading penny stocks, these equities generally lack a following in the investment community. Therefore, liquidity is a serious concern: It's not uncommon for retail investors to get stuck in a position for several days or weeks until there is enough supply or demand to enter or exit, experiencing serious price fluctuations along the way. With penny stocks, it is easier for traders to manipulate prices and make them look weak or strong. (For related reading, see " The Risks and Rewards of Penny Stocks ")

Is per share better for penny stock?

A per-share structure may be better suited for investors who are buying a relative ly low number of shares and may not be the best for pen ny stock trader s. It may prove more useful to choose a broker that offers a relatively low flat rate per trade, regardless of how many shares are involved.

What to consider when opening a trading account?

Opening an Account. There are many factors to consider when opening a trading account, such as ease of transferring funds, fees and customer service. Brokers specialize in different areas, so take your time to shop around for one that will meet your needs.

How many ratios are there for penny stocks?

There are six ratios, in particular, that should help you to evaluate penny stocks. Let's look at each in turn.

What is the best current ratio for penny stocks?

Avoid any penny stocks with a current ratio less than or near 1.0. Ideally, you'll find investments that boast this value at 2.0 or more - the higher, the better.

How to calculate debt ratio?

This is a simple one, but it is an important one. Just divide total liabilities by total assets. If a company has four times more in assets value than liabilities, the debt ratio will be 0.25.

How many times does a company sell its inventory?

A company which produces and sells its inventory 5 times in a year is twice as efficient as one which produces and sells its inventory only 2.5 times. The inventory turnover ratio will vary significantly, depending on the industry in which the business is involved.

What is a P/S of 2.5?

For example, if the shares trade at $2.50, and the company brought in sales of $1 per share for the year, that is a P/S of 2.5. Lower values are better than higher ones, and anything close to 2.0 or less is compelling.

Why are financial ratios important?

Financial ratios are important tools for investors to use when evaluating the earnings potential of a business.

What does P/S mean in stock market?

However, if you had the share-price-to-sales ratio (price-to-sales, or P/S), you can clearly see if the value of the stock is compelling, or much more expensive than its peers. In fact, using a few simple financial ratios that work well with low-priced shares will provide a crystal clear picture of the operational results and future potential of the underlying business.

How to decide if penny stocks are right for you?

Decide if Penny Stocks are Right for You. The first thing that you need to think about is if you are comfortable with the high levels of risks associated with these stocks. If you find them to be too risky, then regardless of the returns they promise, it would be prudent to walk away. 2.

Why do people invest in penny stocks?

Since the price of these stocks is low, they don’t need to risk a lot of money to invest in them as compared to other stocks. Also, these stocks have the potential to offer higher returns than other stocks since the companies have an exponential potential to grow.

Why are penny stocks so popular?

Many new investors are attracted to penny stocks since they are cheap and expect to turn their investment of a few thousand rupees into lakhs. The internet is full of rags-to-riches stories that usually talk about penny stocks turning multi-baggers. While this is not completely impossible – it is very rare.

Why is it important to assess the fundamentals of a company before investing?

Look at factors like the business structure of the company and assess if it can turn a profit based on its operations. Also, look at the competition, efficiency of the management team, free cash flow management, financial records, and other fundamental factors to understand if the company can do something to change the investor perception and experience an increase in demand for its stocks.

What happens if a company is constantly issuing new shares?

Hence, if a company is constantly issuing new shares, then the value of shares held by the existing shareholders will drop. Avoid companies that have a history of constantly changing its share structure.

Why do companies offer shares?

A company offers shares to raise capital. Usually, investors expect companies to use this capital for expansion and/or growth. However, smaller companies might need to raise more capital or issue employee stock options to attract good talent. This can lead to a dilution in the ownership percentage of existing investors.

Why is it important to consider factors when investing?

Hence, while investing, it is important to consider factors internal to the company and assess its value.

Why is it important to know penny stock patterns?

Being able to identify penny stock chart patterns is an essential tool in any successful trader’s arsenal. Because educated traders use these patterns it fills a sort of self-fulfilling prophecy but for trading. While nothing is ever 100% guaranteed, patterns will help you win in the market more than without them.

What is head and shoulder stock?

A head and shoulders stock chart pattern is a trend reversal pattern. It is shown on a chart by having the chart’s highest high sandwiched between two similar previous lower highs. The left side of the head and shoulder shows where the market was in a bullish trend. When the chart gets to the highest high, you can see the market shift to a bearish trend. Hence, this pattern is for indicating trend reversals.

Why does a stock bounce off its support?

When a stock bounces off its support level, two consecutive times in a given period, it can have a strong increase in price. This is usually due to buyers seeing sellers failing to break the support line. Or, rather, investors seeing that there actually is a solidified level of support for a certain penny stock.

What does a double bottom mean on a chart?

A double bottom chart pattern would be the opposite; appearing as a “W”. When a stock bounces off its support level, two consecutive times in a given period, it can have a strong increase in price. This is usually due to buyers seeing sellers failing to break the support line. Or, rather, investors seeing that there actually is a solidified level of support for a certain penny stock.

Do penny stocks lose more than they win?

Chances are, they will probably lose more than they win with that mindset. This is especially true with penny stocks and their volatility. This is why it is essential to begin learning how to buy penny stocks the right way. And learning some of the most important and common chart patterns is a good place to begin.

What to look for when buying penny stocks?

One of the first factors to consider when choosing a penny stock to invest in is the history of the company offering the stock. A simple internet search can help you find all available research and commentary about the company in question. One of the earliest red flags you can discover about a company is a lack of documentation. If little evidence of activity outside of the company's homepage exists online, this could be an indicator of fraudulent activity.

What is the difference between OTC and NYSE?

The primary difference between the OTC marketplace and a major exchange such as the New York Stock Exchange (NYSE) is the means by which stocks are evaluated for their "quality." For example, a company seeking a listing on the NYSE must meet a series of stringent requirements, such as a collective market value of, at minimum, $100 million. It is certainly not the case that penny stocks are, as a whole, of lower investment appeal if they are unable to be listed in the NYSE, but it does mean that they are likely to attract less attention from institutional investors.

Can you trade penny stocks over the counter?

Given the fact that penny stocks often trade in the over-the-counter (OTC) or "Pink Sheet" marketplace , oversight and regulation of these stocks is much less prevalent than in the more popular exchanges.

Is penny stock high risk?

Penny stocks – or stocks that trade below $5 per share – have gained a reputation as a high-risk, potentially high-reward marketplace for investors who are keen on capturing "the next big thing." However, for every success story that exists with penny stocks, there are an equal number of frustrating losses. With that in mind, investors must be willing to take the time to research the company offering these shares and determine whether or not the prevalent fundamentals are an indicator of future success.

Is penny stock illiquid?

Penny stocks can be very illiquid, and many trade for as little as $0.0001 a share. Don’t compound the risk by trying to short an already cheap stock. Ryan Cockerham is a nationally recognized author specializing in all things business and finance. His work has served the business, nonprofit and political community.

What to know when researching penny stocks?

And that means you’ll need real knowledge about the industry from other sources, not just from the company. Management often engages in “puffery,” trying to move the stock price higher so that they can sell or so the company can issue more stock and keep the business afloat.

Why do people buy penny stocks?

In addition, sometimes people buy penny stocks because they can purchase more shares. It may make people feel like they’re wealthy and stroke their ego to have a thousand or more shares, but your wealth is determined by the total sum invested, not how many shares you have.

How long does it take to sell a stock?

The higher the daily volume, the easier it generally is to sell. If a stock trades 1,000 shares per day and you own 10,000 shares, it would take on average 10 days to sell it all — if you were the only seller. If the stock spikes, you might not be able to sell in time to get that high price.

What is the scam of penny stock?

Penny stock fraudsters engage in two typical scams. The first is called “pump and dump.” A company or an individual shareholder might hire a promoter to send out emails and newsletters hyping a stock, hoping to push the price higher. The newsletter might make all kinds of promises about the company’s products or future (“the pump”) to get investors excited. When the stock moves up as a result of the new demand, the individual or company sells a lot of stock at a profit (“the dump”), ultimately causing the stock to fall

Where are penny stocks traded?

Penny stocks reside in the backwater of the market, on the over-the-counter exchanges, not on major exchanges like the Nasdaq or the New York Stock Exchange. Outside of the big exchanges, companies don’t have stringent requirements for reporting their financials to investors and may not have to report them at all. Key information is often missing about the company, perhaps even what business it’s in. Penny stocks often trade on emotion, and emotion is easy to manipulate in the absence of facts.

Why do investors buy higher priced stocks?

In contrast, investors tend to buy higher-priced stocks because the companies have been strong performers over time. So investors have the luxury of taking a long-term buy-and-hold approach, because they’re investing for years, even decades, rather than speculating.

Why are penny stocks so low?

Their low price doesn’t inherently mean they’re poor investments, but penny stocks are usually priced low for a reason. They often represent terrible businesses, which may be on the verge of bankruptcy or engaged in fraud. Occasionally, there is a company that has fallen on hard times and could find its way back with a strong management team, or a start-up with genuine potential to grow. But those are the rare exceptions.

Share Price and valuation

Beware of Dilution

How to Spot A Possible Winner

The Bottom Line

• When most retail traders look at a penny stock, they often ignore underlying fundamentals, such as the number of shares outstanding. As is the case with all investing, it's important to examine a company’s underlying fundamentals and overlay this information with details, such as how badly the shares are being diluted through the use of stock split...

See more on investopedia.com

Understanding Penny Stocks

Narrowing Down Trading Candidates

• Now that you understand where to trade penny stocks, the next step is to determine what stock to trade. One popular method is to use stock screening tools, such as the one found on the OTC Markets website or Finviz.45 Screening for stocks with a price under $1 is the easiest way to narrow down the trading universe. From here, you can filter the lis...

See more on investopedia.com

Opening An Account

Understanding The Risks

The Bottom Line