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4 ways to Evaluate Penny Stocks The Right Way

· invest,stocks,penny stock,Power Metals Corp,PWM

We have had a few enquiries about the risks and benefits of opening a position with a company such as Power Metals Corp (OTC:PWRMF TSX:PWM).

Power Metals Corp is a penny stock listed on the TSX Ventures Exchange and OTC Markets.

The Securities Exchange Commission defines penny stocks as stocks of small companies priced at or less than $5.

These typically are young companies still at their initial growth stage. Investors seek out penny stocks to get in early on a new company. These companies often have the potential to grow into blue chip stocks that trade on the major trading exchanges. The trick for investors is to know how to look for such promising stocks, and to know when to add them to their portfolio.

Buying a Penny Stock

Penny stocks do not trade on the main exchanges such as the New York Stock Exchange or the Nasdaq. Instead, they trade over-the-counter on the OTC Bulletin Board. This is a quotation system in which market makers set the price of the shares they are selling. Investors who want to buy these penny stocks early usually do so through a broker dealer. The broker dealer will get a quote from the market maker over the phone, via email or through a proprietary trading system.

For a Stock like Power Metals Corp, they have the added liquidity benefit of trading on one of the best performing Stock Exchanges Globally, the heavily regulated Toronto Stock Exchange.

PWM stocks at the time of writing this article

Finding the Right Stock

The prices of most penny stocks are especially volatile. The price can shoot up in one minute and revert the next day. Investors looking to benefit from a rally in the stock can find it hard to predict; such rallies also tend to be short-lived. However, some investors use fundamental analysis to infer when a penny stock is going to experience a growth spurt. One example is looking at the general trends in the industry or sector in which the penny stock company is a part. A Company in a booming industry can have a strong pull on their stocks, making them more attractive to investors.

Reported Company activities and Completed capital financing news can move the price of the penny stock. Updates about the company's ongoing activities, especially if its a good news like positive exploration results, can send the price of the Stock Companies higher. Buy-out news or merger rumours can also send the price of penny stock higher. This is good for investors who already have a share in the company. In order to take advantage of any positive or rumoured events, investors need to keep an eye on the Company and buy-in early. Investors can also keep an eye on larger, established companies in the same sector to see how their stock performance is to see if the Penny Stock is considered a real bargain. Many a times, similar companies in the same industry, especially during times when valuations are not elevated, can eventually decide to merge together if they have complementary business objectives or products.

Another technique used to evaluate penny stocks is to go through this simple 4-step Evaluation Plan. Part of this analysis looks at the company’s fundamentals. Among those criteria evaluated are the company’s balance sheet, its positioning in the industry and how well it is differentiated from other companies. Investors who are aware of the company can dedicate time to research and then buy the stock. The effect on the stock price is compounded as investors flock in droves to buy up the cheap, familiar stock.

A simple 4-Step Evaluation Plan

1. Balance Sheet Reality - The Balance Sheet is the first stop we make in evaluating Penny Stocks. Before we waste any time on further review, we use the balance sheet to separate the "ideas" and "lottery-ticket companies" from solid penny stock businesses which are real companies actually trying to accomplish something and grow. These are the type of companies which will actually be around the following year. The Balance Sheet will show what the penny stock owns, compared to what it owes. Be cautious with companies who put unrealistic values on line items like "Goodwill" and treat it like an asset. Cash is an asset, properties and equipment owned are assets. A Property, such as a piece of Greenfield Land, which have been commercially proven to provide economical benefits are also recognised as assets. The perceived value of a company's brand is not (despite what the CFOs will tell you).

2. New Stock Offerings/Buy-backs/Splits - Keeping an eye on movements of money, and changes in the number of available shares, is very important to assess the ongoing health of a business. News relating to buy-backs, share splits, reverse splits, offerings of new stocks, etc... can all cloud the real picture.

For example, if a penny stock's earnings per share are increasing, but they did that after buying and eliminating half of the shares, their profits may actually be decreasing, despite appearances of growth.

Typically, issuing more share of stock into the market can help raise money for a business, but it can be detrimental for the penny stock's share price. Meanwhile, a reverse-split is also often negative for the penny stock's long term momentum.

 

Also, when looking into cash flow, it may help to think of that as the blood in the veins of a business. Properly managed movements of money can be even more important than the income statement or balance sheet. Cash flows, include obtaining money from private investors, can buy a business years of operations, even when there are no revenues. This is especially important for newer penny stock businesses or businesses which require time to generate revenue.

3. The Executive Team - This is public knowledge. You know what else is in public knowledge? Who did those execs worked with previously and how are they related to each other professionally. It just takes a few quick Google searches, and you should be able to build a picture of how successful they were in their previous positions. Put on your detective hat and snoop. Remember, in stocks just as in life, people will tend to do exactly what they have always done. Winners win. Losers... not so much.

4. Value Proposition - What makes this Company's business different from its competition? Being unique will go a long way toward success.

There are a lot of exploration companies, but if one is operating in a commodity that is in demand today and in the near future, they will have a greater chance of being bought out. But that alone is not enough.

Strong value proposition is important, ONLY if prospects, shareholders, peers and other companies and customers know about them. Finding good penny stocks is not about looking for companies with unique selling propositions. It is about discovering those companies who are doing a great job already promoting their property, product or service differences.

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