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Penny Stocks III – How To Select Good Ones?
Op-ed, Tradeable | 12 March 2013
By: Simeon Ang
Articles (125) Profile

Even with all the strategies (to recap on what strategies you can take when investing on penny stocks, do take a look at the initial two parts of our series here and here)in the world, you would not be able to conquer anything without a trustworthy and able general. And so it applies to penny stocks and investments. You might have all the strategies and capital to invest, but without a counter that you are comfortable with, the whole investment promise collapses and spirals into pure speculation.

So, how does one separate the truly great generals from the lemons? Here are five easy-to-follow steps that you can easily follow in your endeavour to find your next Alexander the Great or Guan Yu (关羽) of stocks.

Step 1: Limiting Your Universe
The Singapore Exchange has close to 800 stocks listed. Of these, only a fraction is suitable to be called penny stocks. The general rule of thumb used by analysts to decide if a stock qualifies is whether the stock trades below $2 apiece.

Investors should limit their penny stocks further. From the range of the lowest price possible, $0.001 to $1.50. Why limit to this seemingly arbitrary figure? Mainly because if it were any higher, there would be a diminishing amount of room for the stock to run.

Step 2: Are Other Investors Interested?
Previously, I wrote that penny stock investors should not heed the calls of “loud hailers” on internet forums. Instead, to see if a stock has garnered interest amongst the investing community, the investor has to see if there is sufficient demand. This can be measured reliably by the average daily volume of the stock.

Ideally, the stock should have at least a volume of more than 100,000 units changing hands each day. Demand here is measured from both retail and institutional investors.

Step 3: Fundamentals
Here comes the complicated part (hey, I said easy-to-follow, not easy-to-execute), fundamentals research. The good thing about this step is that you decide what kinds of criteria you want to look at. Will it be EPS (earnings per share?), discount to NAV (net asset value, meaning the stock is trading at a lower price than its total accounting value) or will it be others?

Personally, I would look at both of the above ratios that I have mentioned. EPS is a good and easy way to gauge if the company is profitable. At the same time, if the company is trading at a discount to NAV, then perhaps, the market has not properly valued its true potential yet.

Also, when researching on the fundamentals of the penny stock, ignore dividends. Many penny stocks that appear to have massive dividend yields are simply using an arithmetic trick where a one-time payout is annualised out. These special dividends are often unreliable and make a poor selling point. Ignore all dividends when picking a penny stock investment. While the payouts are nice if you qualify, they should not be a deciding factor on when to buy or sell penny stocks.

Again, I would like to stress that the criteria for this step has to be comfortable with you. Only then should you proceed to step 4.

Step 4: Price Trends
Is the stock trading downwards? Or has it just recently attained an all-time high? If there are stocks left in your universe after step 3 that have any of the above, it is better to ditch them.

You should be looking for stocks that are trading upwards but have not yet attained all-time highs. This goes along the same lines as the rationale in the first step. If it has already attained an all-time high, is there much room left for it to run? The answer is more likely a no. It is thus better to just cast these doubtful ones out and concentrate on the remaining few that fit the bill.

Step 5: Checking The News
Which sector offers potential for growth? Which country seems to be weathering the economic gloom well? All these macroeconomic factors can be quickly assessed by checking through the news at known media outlets such as Bloomberg, CNBC, CNA or Shares Investment

Better yet, if there are articles from these outlets that highlight penny stocks, then all the more you should be more confident in dipping into your pockets to invest in the stock.

Ultimate Goal: Finding That One Penny Stock
Your ultimate goal in penny stock investment is exponential returns that you would otherwise be unable to attain with blue chip stocks. However, it is a fact that this search will not be easy and it will take serious work to find this rough diamond.

As Robert Kiyosaki once said,

“To find a good investment, look at 100 but buy only one.”

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Simeon, an LSE graduate, is currently the editor of Aspire. He specialises on topics surrounding trading psychology, politics and macroeconomics.

Please click here for more information about this author.

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The Shares Investment editorial team welcomes constructive feedback on our coverage and content. We would also be delighted to answer any questions on the above article. Leave us a comment below, and we'll get back to you shortly!

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