How to pick penny stocks?

A penny stock is a very loose terminology referring to companies with share prices of below $5 and market caps under $200 million. They are also often called nano cap, small cap or micro cap stocks. Penny stocks have been referred to as the 'slot machines' of the investment industry because there can be a potential for both excellent gains and a complete loss. If you are a bit confused on how to pick penny stocks, there are a few rules of thumb to know:

Penny Stocks: Why they are volatile
Some companies that are listed in the penny stock arena don't have a good track record of solid financial performance. In considering how to pick penny stocks, you should be aware of this as a major priority. While they are the most manipulated of all of the stocks on the stock market, they are also fair game for scam artists. Limit the tiny stock to five percent or less of your portfolio.

Hone Your Skills on Mid and Large Cap Stocks First
Before jumping into the penny stock arena, you need to be an expert on reading a balance sheet, income sheet and cash flow statement. Use the mid and large cap stocks as your guideline so that you will be able to recognize the better options in penny stock. Examine to make sure the company has enough cash to carry them to the next year (and onward). Get yourself accustomed to recognizing those companies that seem to be continual performers.

What Penny Stocks to Not Include
If there are companies within industries that you are not familiar with or seem to be confusing, don't include these on your list for consideration. Other things to watch for: stocks that are not traded on one of the major US exchanges such as bulletin board or OTC. Any time you receive an email that recommends a penny stock, understand that marketing companies are sometime paid to promote and they are probably not worth it. Review the annual income of a company. If it's $10 million or less, don't include it on your list.

New Industries
There is a lot of credence in the newly rising eco and green companies. This is a new industry that is growing steadily. Do a bit of homework in finding out who the company is and the direction they are heading in. The best type of new industry company is one that has been in business four to five years.

Key Indicators For Your Penny Stock List:
A company that has a consistent record of generating cash combined with growing their free cash flow over time. Do not include heavy debt load companies.

Don't just look at share prices. Do a comparison of price per share against book value per share. Also referred to as comparing assets less the liabilities.

If you are considering a penny stock, you should be buying at a low multiple compared to the cash flow. The best would be six times under.

Newsletters:
Keep yourself up to date on informational newsletters that focus on penny stocks. Glean through them and make sure there aren't personal investment interests involved.

Analyst's Ratings:
Use this as a very minimal part of your consideration. If the company is included in an analyst rating it may add a point or two to your comfort level.

The information supplied in this article is not to be considered as medical advice and is for educational purposes only.