Price Drivers in Penny Stocks

The Factors Which Drive the Prices of Penny Stocks

morgan freeman sirius XM
morgan freeman sirius xm. Cindy Ord

Successful investors understand the price drivers which move shares. They also recognize that those forces are very different between penny stocks and massive, multi-billion dollar corporations. Something which can really affect a smaller stock, may not be as relevant in terms of larger corporations, and vice versa.  Depending which type of investment a person is trading, their styles should adapt.

Larger, multi-billion dollar corporations typically see price moves based on items like earnings, revenues, and financial ratios (and related expectations and disappointments).  On the other hand, penny stocks have fewer factors to analyze, mainly because they are often very small companies, or are newly established businesses. 

The major price drivers for most penny stocks are speculation and potential.  The value in the shares is mainly made up of two concepts:

1. How valuable their customer base "might" become

2. What they "could" possibly do with it

Tiny and/or thinly-traded companies are also affected by mentions in media, online rumors, and new contracts or customers, any of which can instantly and significantly move the price of the shares.  On the other hand, you will not see Disney double in price when they land a new contract, or Microsoft triple just because they were featured on CNN.

Examples of Positive Price Drivers - Large Corporations:

  • Strong financial reports (earnings/revenues were better than expected by most)
  • Overall market is climbing (rising tide lifts all boats)
  • Change of CEO (this can be good for the shares if shareholders did not like the previous CEO)
  • Optimistic industry reports (commodity prices expected to rise, industry expected to grow)
  • Addition to major index (for example, joining the S&P 500 attracts more institutional investors)
  • Increasing dividend payments

Examples of Positive Price Drivers - Penny Stocks:

  • Takeover rumours
  • Announcement of share buybacks
  • Underlying industry gets "hot"  (think marijuana, 3-D printing)
  • Businesses in the same industry do well (penny stocks often trade in sympathy)
  • Neighboring land claim strikes diamonds / gold / oil
  • Alliance or contract with major company (Walmart, Google, Microsoft)
  • Winning legal settlements
  • Moving to a better stock exchange
  • FDA approval

Above are just a few of the numerous price drivers which will have impacts on the shares. There are just as many negative price drivers, and again they will differ depending on the size and nature of the underlying company. Large established corporations react in a different way and to different price drivers than tiny penny stock companies with few employees and no revenues.  

You may have heard the expression that the larger something is, the more energy it takes to move it.  Unfortunately, that is why one single event can derail an entire penny stock business, and it becomes ever more important to perform exhaustive due diligence on any low-priced shares.

All potential investments need a thorough analysis review, whether they are large or small.  At very least, every potential stock market purchase should be passed through your own due diligence.  In addition to this, when it comes to lower-priced shares and penny stocks, we suggest you also perform 29-point Leeds Analysis.

Recognizing the price drivers behind the investments you purchase is one stage to bringing in superior profits.  However, this concept should be taken a step further, as sometimes the forces moving the shares change in an instant.

An example of this was the merger between Sirius Satellite Radio and XM Satellite Radio.

  Up until the combination of the two companies, trading was based almost entirely on potential and speculation

Investors drove the share prices higher towards ridiculous valuations, justifying their purchases based on potential cost savings which would be realized, and the elimination of costly competition between the two companies.  It certainly had nothing to do with actual financial results, considering the absolute "trainwreck" of a financial position (to quote my opinion and wording).  

The instant the merger was realized, investors stopped focusing on future potential and cost savings and were forced to shift their focus to actual operational results.  The shares became valued based on fundamentals like revenues, earnings, financial ratios, and the valuation of shares.  The stock of the merged company tumbled a long way and quickly.

Always know the true price drivers moving the shares you own. Be honest with yourself, because there may be times you buy a low-quality company, but have good reasons for the choice. If you purchase with an understanding of the price drivers, you will have clarity of when to take profits, when to buy more, and when to get far away from the position.