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Penny Stocks: A Good Investment

Aug 26, 2007
Penny stocks can be a tempting investment. The share prices are so low that most people have the tendency to believe that they make for an excellent investment because with the price being so low, it would seem that the stock can not go anywhere but up. This is sometimes the case, but if you are a neophyte investor, there are some things that you need to be aware of before investing in penny stocks.

Penny stocks are defined differently depending on who you talk to. Stockbrokers define them as any stock that trades below $5 per share. Regulatory agencies sometimes classify them as a stock with a price below $2. But, generally speaking, a penny stock is any low-priced security that trades on one of two exchanges; the Pink Sheets or the OTC Bulletin Board.

The Pink Sheets are an exchange where most startup companies first get listed. There are no listing requirements to be traded on this exchange. A company does not have to have any sales, nor does it have to reveal how many shares outstanding it has to qualify for the Pink Sheets.

The reason why a company tries to get listed on the Pink Sheets, even though their stock will not go up in price because they have no sales to speak of, is because it gives their company more substance and credibility; it is typically easier to attract additional capital, obtain financing, and execute contracts and agreements if a company is publicly traded, even if it is on the Pink Sheets. Also, it is easier to get transferred from the Pink Sheets to one of the larger exchanges than it is to go from being a private company to hopping directly on to one of the major exchanges, such as the NASDAQ or NYSE. Companies listed on the Pink Sheets trade as ridiculously low as $0.00001 per share, all the way up to $500 per share and sometimes beyond. Foreign companies often have some of their shares sold in the United States by listing them on the Pink Sheets.

The OTC (Over-The-Counter) Bulletin Board is similar to the Pink Sheets. This exchange consists of relatively young companies either with no sales or a small amount of sales. Companies listed on it are sometimes fully reporting (meaning that they reveal how many shares they have outstanding and what their balance sheet looks like). Often, companies go from the Pink Sheets to the Bulletin Board once they are ready to become fully or semi-reporting.

Most publicly traded companies that are now listed on one of the major exchanges (NASADAQ, AMEX, NYSE), at one time or another, were penny stocks listed on the Pink Sheets or Bulletin Board. Rarely does a company go from being private directly to one of the 3 major exchanges. Google is a rare example of a company that was able to do that, because they were so successful so quickly. But, most companies have to pay their dues and edge their way up from the penny stock exchanges to the bigger ones.

So, investing in penny stocks can be an excellent investment because some of these young companies will one day be worth a fortune. The hard part is finding the right company to invest in, because for every successful startup company, there is also one that fails within the first year or two.

To find the right company, there are a few things you need to look for. Number one, you need to do some research and try to find out how many shares the company has in its float. The float is the number of shares that are currently being traded. Companies listed on the Pink Sheets usually do not officially report this number to the public, but with a little research, you can usually find out. It is usually contained in articles written about the company, or in TV or radio interviews with company officials that are sometimes archived on certain websites. You can also look for the information on message boards or forums where stock traders chat with each other. Simply do a search on Google and read every article ever written about the company, and you will likely find out about their float. This is important because you do not want to invest in a company that already has something like 500 million shares in its float. Companies with this kind of share count are likely having problems moving forward, so they have issued more and more shares to raise money just to stay alive. You want to look for companies that have approximately 5 to 100 million shares in their float.

Other things that you should look for in a new company are barriers to entry, patents, and consumer demand. Here are the questions you need to ask yourself when analyzing the probability that a company will be successful:

1) Barriers to Entry: Are there are obstacles that will make it difficult for the company to sell its products or services?

2) Patents: Is the product that the company is going to sell patented? A patent will prevent other companies from producing the exact same product.

3) Consumer Demand: Will there be a demand for what the company is selling? Sometimes a company has a great new invention or an exciting technology, but if it is not something practical that consumers are going to want or need, then it does not matter how great it is.

I hope this information has helped you to get acquainted with penny stocks. Try to set aside some money for investing and start while you are still young. The earlier you begin, the more money you can potentially make down the road. Do your homework on the companies you are going to invest in and you will do fine.
About the Author
Jim Pretin is the owner of http://www.forms4free.com, a service that helps programmers make email forms.
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