Penny Stock Haven

 

What are Penny Stocks?

Individuals new to investing in penny (micro-cap) stocks should realize the difference between penny stocks and the more conventional blue-chip investments, like a Microsoft or General Electric.

There is no universal definition of a penny stock, as some define it as a stock priced under a dollar where as others believe five dollars to be the benchmark. The Securities Division considers a “penny stock” defined if it trades at or under $5.00 per share and trades on the pink sheets or on the NASDAQ/OTC. A true penny stock will have less than $4 million in net tangible assets and will not have a significant operating history.

Penny stocks are traded in the over-the-counter (OTC) market. The OTC market includes the OTC Bulletin Board (OTCBB) and the Pink Sheets (a name derived for the color of the paper in which they are printed on). Investors tend to see much greater price volatility amongst companies in the OTC market. Most companies lack a stable stock valuation and consistent demand for their stock (liquidity). Price volatility and lack of a reliable exit strategy in the case that an investment plummets can bring fear to some investors, where as others realize that one good pick could provide an ROI (return on investment) hundreds of times greater than on any larger market investment.

Many penny stock companies start out raising money through an initial stock offering or a private placement in an effort to develop products or services or fund an exploration. Though very rare relative to the thousands of companies on the OTC, if a company succeeds in utilizing it’s capital correctly (though many factors can temporarily drive stock price), a company’s value could skyrocket in a relatively short period of time and make an investor extremely wealthy. Be advised that proper due diligence is necessary in any investment decision, but especially when investing in penny stocks.

Overall, there is much more risk in investing in penny stocks compared to securities like blue chips, treasury bonds, or defensive stocks- but in a diversified portfolio, investments in penny stocks add a potential for huge gains with a typically small up-front investment.

Understanding the Pink Sheets

The Pinks Sheets are relatively unknown or misunderstood by most investors. There are over 18,000 public companies in the United States. The largest and most well-known companies trade on national stock exchanges like the New York Stock Exchange (NYSE), the NASDAQ system, and the American Stock Exchange (AMEX).

There are stringent listing requirements that need to be met and maintained in order to be listed on these exchanges.

The remaining publicly traded companies that don’t meet these requirements are traded in the “world” known as the “non-NASDAQ OTC” market. There are two main divisions of the OTC market called the OTC Bulletin Board and the Pink Sheets. OTC Bulletin Board companies (OTCBB) report their financial health and other public information through quarterly (10Q) and annual report’s (10k). This is the most notable difference between the two.

Companies on the Pink Sheets are not required to disclose financial statements or company operations. Most companies on the Pink Sheets are there for one of three reasons:

  1. The company is a shell that has no existing operations or business plan and is looking to be purchased.
  2. A company is in the developmental stage.
  3. A company that chose not to pay the expenses of legal counsel, accountants, etc. that are necessary to be a full-reporting company.

Note: Many small companies would rather cut these expenses and wait until the company is healthy enough to just skip the OTCBB and move to a national exchange.

The Successful Penny Stock Investor

Successful small cap and micro cap investors do not avoid risk! They view the possibility of reward as a greater motivation than the fear of loss. The mental challenge of studying services, products, and management overrides the fear that comes with the potential for loss. One’s own belief in their due diligence and capacity to analyze facts and projections is the prime motivation. The gain’s being an important but secondary motivation and a pleasant reward for quality investment decisions.

Ask yourself these questions to help decide whether the small cap and micro cap market is right for you. If you can answer yes to most of these questions, small and micro caps might be an exciting and fruitful investment option: Check with financial and product comparison sites like Love Money for additional information and ideas.

  • Do I have the ability to view risk as an intellectual challenge to be solved rather than fear it as a chance for loss?
  • Do I possess the courage to follow my own convictions?
  • Can I deal with, and more importantly analyze the unavoidable errors that come with micro-cap investing?
  • Do I have creative and intuitive thinking?
  • Can I remove emotions from the facts when making investment decisions?
  • Do I understand the alternative ways of thinking that are necessary to invest in the micro-cap market?

Technical Analysis of Penny Stocks

Technical analysis is a method of analyzing stock statistics based on market activity, past prices and volume. It is a method to look for patterns and indicators on historical stock charts that will determine a stocks future performance. Most technical analysts believe that stocks move with very predictable trends and patterns.

The problem that lies with technical analysis in the penny stock market is that very few OTC companies have a consistent or reliable trading history. There are a number of reasons for this. Some companies are new, some are shell companies with no business operations, some lack the fundamentals or direction to garner investor support, and then there are those few quality companies that not enough investors are aware of.

Most OTC companies have limited budgets and do not possess the financial muscle to communicate their story to enough people to build a consistent demand for their stock. Every so often there may be a spike in the stock from a positive press release, but for the most part there is not enough consistent investor demand for the stock to maintain a reliable trading history. Without consistent historical market data, no reliable pattern can be found; therefore making technical analysis a virtually useless method.

OTCBB vs. NASDAQ

The OTCBB is a quotation medium for subscribing members, not an issuer listing service, and should not be confused with The Nasdaq Stock MarketSM. OTCBB securities are traded by a community of Market Makers that enter quotes and trade reports through a highly sophisticated, closed computer network, which is accessed through Nasdaq Workstation IITM. The OTCBB is unlike The Nasdaq Stock Market in that it:

  • does not impose listing standards;
  • does not provide automated trade executions;
  • does not maintain relationships with quoted issuers; and
  • does not have the same obligations for Market Makers.
Feature or Requirement OTCBB Nasdaq OTCBB Nasdaq
Minimum quantitative listing requirements No Yes
Listing and maintenance fees to issuers No Yes
Requirements to maintain quotation or listing Yes* Yes
Real-time electronic quotes for domestic issues Yes Yes
Minimum Form 211 or listing processing time 3 days 6-8 weeks**

** Issuers of securities which began quotation on the OTCBB after January 4, 1999 are required to file periodic financial information with the SEC or other regulatory authority to maintain quotation eligibility.

*** A Form 211 is not required for listing on Nasdaq; however, the average time of approval for listing on Nasdaq is 6-8 weeks.

The OTCBB is distinct from the Pink Sheets. The Pink Sheets are not owned or operated by The Nasdaq Stock Market, Inc. or the NASD. The Pink Sheets LLC is a privately owned company whose Electronic Quotation Service provides an Internet-based, real-time quotation service for OTC equities and bonds.

The benefit of being a reporting company on the OTCBB vs. a non-reporting company trading on the Pink Sheets:

  • When a company is reporting and files with the SEC, information and audited financial statements are made available to the public. Access to this information helps the public evaluate the strengths and shortcomings of the company and decide whether to buy the stock.
  • The primary benefit is that public access expands the potential to gain new stockholders. With so many potential companies’ to invest in, especially in the small cap and micro cap market, access to audited financials and other vital information could be the difference in choosing one company over the other.

Things to look for when examining the viability of a penny stock:

Financial Health
Understand how much debt the company is carrying and how much working capital they have or need to grow the company. Many company’s use investor money just to stay in business. If the company is not using money to grow, an investor can not count on any legitimate return.

Company’s use of proceeds
What does the company intend to do with the money acquired in an offering. This helps the investor determine how much of the money is going into things that will grow the company compared to suspect activities such as loans to insiders, etc.

Management
Find out the background and experience of officers and directors. Do they have the expertise to handle the company’s objectives? Have they walked the road of success before? Make sure a pharmaceutical company you like is not being run by a guy that has 40 years experience in the oil industry.

Product analysis
Understand how far along in development the product is. Is money being raised to market the product, or to develop it? Read the prospectus carefully to discover whether there is a viable product to build a company around.

Company tenure
How long has the company been in business? If it is a new company with little operating history, there is more of a chance it could be a “fly by night” fraud.

Dilution
Promoters often possess huge numbers of shares at no cost. When those shares hit the market it can dilute share value significantly. As a rule, 75% or more dilution is a red flag.

Conflict of interest
Be careful to watch for any transactions among insiders and promoters that can not be deemed as “clean”. Interest-free loans to insiders and large amounts of free shares given to promoters can be warning signs.

Past or present litigation and/or investigations
Any lawsuits filed or investigation’s done on the company, insiders, or promoters.

Good luck with trading!