4 Must-Ask Penny Stock Questions

4 Questions Every Penny Stock Investor Must Ask Themselves

pros and cons of penny stocks
Pennies with calculator and magnifying glass. Getty Images

Congratulations!  If you are delving into the action-packed, fast-paced world of penny stocks, then you have plenty of ambition to go along with your iron-clad stomach!

Whether you've formerly found your opportunities in penny stocks, or you are just about to begin, there are 5 questions that must be addressed immediately.

1.  Is penny stock trading appropriate for you?

Speculative investments are not for most people.

 Penny stocks are more appropriate for people who:

  • have a high tolerance for risk and volatility
  • are starting with limited funds to invest
  • will only use risk money
  • will do proper due diligence
  • are going to do the work required to trade penny stocks properly

If you decide that you are a good candidate for penny stock trading, then it is time to look into those shares which may have caught your eye.  This becomes the perfect time to ask the blunt question...

2.  Is this a scam?

For most first-time and brand new penny stock investors, the answer to that question is YES!  The proof of this is the same process outlined here for all levels of investors to avoid the scams.  

Ask yourself, how did you hear about the company in the first place?  If it was from ANY of these free sources mentioned below, it is almost certainly someone trying to trick you into buying shares of some "pig in lipstick" company.

Scam artists benefit by making groups of people buy, which drives up the price of the underlying (and worthless) stock, and then sell their shares into their artificially-fabricated demand.

Avoid every penny stock you first learned about via:

  • ANY free source
  • message boards
  • newsletters
  • websites
  • postal mail
  • faxes
  • e-mails
  • co-workers, friends, or relatives
  • news releases (paid for by the promoter)
  • advertorials
  • any source compensated/paid by the underlying company

Once you give the potential investment a quick once-over scam check, you might want to proceed to the next few questions.  By asking yourself a few more things, you'll be even more educated and confident in the investment.

Once you move beyond free promotional scams, you will find that there are some high-quality sources of penny stock picks.  Unfortunately, most of them are ridiculously uninspiring.  

These services typically make their money via paid subscription fees, such as my own company which publishes the Peter Leeds Stock Pick alert service.  You'll just need to consider the quality of the "brain you rent" if you proceed in the paid-newsletter direction. 

Also, make sure they have a 100% Unbiased Guarantee, or else they may be accepting money from the penny stocks they are hyping up to you.

3.  Will the company even survive for the next few months?

Most penny stocks are not very good investments.

 This characterization is often fitting, since many of them have huge debt loads, no revenues, ongoing losses, and multi-billion dollar competitors in the space.  

You should make sure their assets (what they own) are greater than their liabilities (what they owe).  Also take a look at their revenue levels, customer retention rates, and market share.  Does their business model work?  Proof of concept means everything to early-stage, speculative companies  (which describes many penny stocks).

For publicly-traded businesses, they release this information every three months.  (This does not apply to penny stocks trading on the awful markets, such as Pink Sheets and OTCQX, which you should never be looking at anyway)!

You can learn all about what to look for, and how to understand it, from dozens of free sources on the Internet.  This required "work" is actually much simpler and fun than the majority of people realize.

4.  Will the company grow?

Having revenues is one thing, but having growing revenues is an entirely different situation.  What really matters with any stock market investment is how quickly are they getting bigger - the majority of any stock price will be based upon this specific price driver.

Revenues of $1 million with a 20% pace of growth each year is much more valuable than a business with sales 3 times greater, but growth of only 5%.

Other metrics of how a penny stock business can grow, each of which will affect the share price, include growth (or shrinkage) in:

  • the overall market
  • their share of that market
  • debt load
  • patents and other intellectual property
  • brand awareness
  • employees, managers, and executives

By asking yourself these four simple questions explained in this article, and answering them honestly, you will be protecting yourself from the downside and scams, while uncovering the best investments.  In the fast-paced, hyper-volatile world of penny stocks, this will be a recipe for success.

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