How to Research Penny Stocks

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By Lija Rasa
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Research penny stocks before you buy.

Penny stocks, especially those traded at over the counter exchanges, are a different kind of stock breed when it comes to research. There are thousands of penny stocks listed on OTC Bulletin Board and Pink Sheets, and other than sifting through lots of listings there aren't very good ways to screen them. Without subscribing to some paid penny stock research service, that is.

Moreover, penny stock prices are often manipulated by market makers or pump and dump schemes. Beware that many investors lose a lot of money because of penny stock manipulation.

Yet if done wisely, it is possible to get phenomenal returns from penny stock trading. Here are some ideas to help you do your own penny stock research.

Difficulty: Moderately Challenging

Instructions

Step 1

Note that there are many definitions of penny stocks out there. The Securities Division considers any stock trading below $5 a penny stock. Most investors, however, search for stocks trading under a dollar when they are intent on buying a penny stock. Yet others only consider stocks that are traded on OTC exchanges as penny stocks. I personally prefer the "under a dollar" definition.
Step 2

First you have to find penny stocks worth researching. Use a stock screener to quickly find under a dollar per share stocks traded on major stock exchanges. Check OTC BB and Pink Sheets websites for thousands of penny stock listings. It might be a good idea to search for companies by sector. For instance, if you think that alternative energy is becoming hot, look for green energy penny stocks. Those start-ups might soar when they get government contracts, etc.
Also check the resource section for an article that elaborates on how you can find the under a dollar stocks on your own.
Step 3

When you know company name or symbol, you can find price charts and other data on sites like Google Finance or Yahoo Finance or others that offer free financial data. In particular, you want to look at:

Volume - look for at least a few million shares traded daily and small bid/ask spread;
Balance Sheet - check how much cash the company has: more cash in the bank increases company's chances of survival in a bad economy;
Net Profit Margin - very low profit margins might mean that the company will soon be losing money.
Step 4

Be very careful when buying penny stocks you find listed on so called hot penny stock lists. Always check the price chart - if a stock went up dramatically over the last few days, chances are, it will go down very soon. Very frequently, a hot penny stock list is nothing more than a pump and dump scheme. Penny stock lists found on MSN Money are usually based on legitimate stock analysis, but their price may have gone up precisely because they were on that list, and will go down soon when investors take their profits. If the company does indeed have sound fundamentals, watch it's stock for a few weeks, and buy it when the price goes down a bit. You can cash in when it posts good news later on.
Step 5

Before you invest in a penny stock, try to learn more about the company - the products they are making, the people that are leading the company, etc. You can start by visiting their website, and continue by searching more on the web. You can also call their investors relations contact numbers to ask more questions. If you don't believe in the products the company makes, you might not want to buy the stock either.
Step 6

Finally, remember that no matter how much research you do, penny stocks are still very risky investments. Do not invest money that you can't afford to lose. Generally, the suggestion is to not invest more than 10-20% of your entire stock portfolio in penny stocks.