People turn to penny stocks for quick buys in the search of even quicker profits. I don’t like that approach. I prefer to find solid companies with the potential to grow and thrive in their industry. Even though penny stocks carry a considerable risk, there are methods you can use to find the next billion dollar company.
What are the 7 signs that could mean a penny stock could grow to become a giant mega company?
- Solid management teams & dependable high ranking officers
- Strong support for industry products
- Steady increases in market share
- Upward trending money flows
- Consistently high trading volume
- An increasing or sustainable cash flow
- Solid fundamentals & a healthy industry life cycle
Penny stocks are companies that trade for less than $5 per share, and they are usually priced so low for a good reason. Penny stocks could be companies that were once thriving but have since took a turn for the worse, they could be companies that are stagnant and not growing anymore, or they could be new companies that are making their way into the market.
Penny stocks are risky and volatile by nature, and they are often used by influencer to make money by price manipulation. However, once in a while, a penny stock will reward a competent investor, just like Monster Beverage Corporation (MNST) did for me when I bought it for $4.26 per share back in 2008, and sold it in 2018 for $66.86 per share.
The 7 Signs of a Good Penny Stock
Solid Management & High Ranking Officers
Any business needs a good management team, especially a penny stocks. A good set of high ranking officers can turn a struggling or stagnant company around and launch them to new heights.
More importantly, a well known CEO or manager can have a positive impact on the companies perception to the public, not just in terms of share price, but consumer product use. Consumers base purchase on trust, and if a trusted person is heading a company, the public will be more generous towards their product or service.
The bottom line about managers is, when an experienced management team come onboard, and they have vested interest in the company via share ownership, it can provide a sense of security with investors.
A good example of good management is when the tech company Take Concur bounced back from the ‘.com’ bubble. After the bubble popped, they we sitting at around $0.35 per share, they since rebounded back to over $129 per share in 2014 before they were bought by the software giant SAP SE. The recovery was due to many factors, but one that stood out was the strong vested interest of the companies President and CEO Rajeev Singh.
Singh had founded the company in 1993 and filled many management roles over the companies lifespan, the management roles which ultimately lead to the recovery of the business and the huge sale in 2014.
Strong Public Support of Goods or Services
We’ve all heard of the Fidget Spinner. The trend that took the world by storm then fizzled out. This type of trend is of high demand but short life.
On the other hand we have social media, the trend that keeps on growing. With more users now than ever before, social media startups are hugely funded and generously bought.
If a company has a product that members of the public want in high demand, it’s only a matter of time before the company hits it big. Although there are some things to consider such as, patent filing, design flaws, and any potential competition. Viral trends can send companies sky high.
A great example of this is in the renewable energy sector. Companies such as Ballard Power Systems (BLDP) started the decade as penny stocks, but know because of the development in fight against global warming they are some of the leading growth companies in the USA.
|Company||Starting Share Price||Current Share Price||Percentage Gain|
|Ballard Power Systems||$1.27||$13.14||934.65%|
|Vivint Solar Inc||$2.76||$10.91||314.49%|
Because of the serge in people and government thinking about climate change, these renewable energy companies hit it big with investors. Not only because they were aiding in the mission against global warming, but because they were doing a good job at it.
Steady Increases in Market Share
When a company increases its market share, it usually implies an increase in revenue, greater acceptance from customers, or eased pressure from competitors. The best case scenario is a steady and predictable increase in market share, we don’t want it to fluctuate too much from one period to the next.
This is a really simple one. Increasing market share means a companies growth is going well.
You can find most of the information regarding a companies market share on Yahoo Finance, or you can call the company’s investor relations officer.
A good way to see if a company is increasing it’s market share though the public eye is to put your ear to the pavement and ask these questions:
- Is the company coming up with any innovative ideas?
- Does to company actively engage with customers?
- Is the company acquiring new customers at a steady rate?
- Are company standards consistent?
Money is Flowing into the Company
When I say “is money flowing into the company” I mean are people buying shares?
When the flow of money is on an upward trend the result is an increase in share price, because the demand for that company has went up. However the same is correct for the opposite flow of money.
Money flow is more of a technical analysis technique, which is still a valid form of analysis. It can be shown on almost all charts as an indicator, I like to use the Money Flow and On Balance Volume (OBV) indicator. You can get these metrics for free at Big Charts.
A huge indicator of a rising stock is if the OBV indicator is on an upswing or showing a strong positive trend, but the share price for the company remains unchanged. This could mean the share price for the underlying asset is going to move higher. Unfortunately these events are not common, but a strong positive trend is good either way.
Consistent High Trade Volume
Yet another technical analysis method, similar to money flows. If a company has consistently high trade volume, it could indicate higher demand for shares, which in turn would increase the share price.
Generally spikes in volume are a good thing, companies tend to see share price increase until the demand subsides.
When it comes to penny stocks, we are looking for the trade volume to double its daily average, and then maintain this for over a 1 month. This gives us confidence that the increase demand wasn’t a result of a big news story, but for longterm excitement and hopefully growth for the company.
Remember to keep an eye on which way the volume is moving, if the volume is out of the stock it is going to cause a decrease in price. Use this metric alongside the money flow indicators.
Increasing Cash Flow
You have to treat a penny stock investment with the same factors you would a blue chip stock.
What is the number 1 indicator that a company is doing well and growing?
Solid cash flow statements… If a company wants to grow, they need cash to invest around the business. Whether that’s by employing more people, developing new products, or building new factories. You can’t do this without spare cash.
There is no formula when it comes to cash flow statements to say, this one is good and this one is bad. It all depends on what the company does with it.
We are looking for at least 3 years worth increasing revenue, and 3 years of increasing operating cash flow. This not only gives investors confidence in the companies ability to grow, but it also gives the company a cushion of cash to fall back on if they hit a rough patch.
The operating cash flow will give rise to innovation across the company, and if they have a structured plan, hopefully it will bring increasing profits for investors.
The Industry Life Cycle & Fundamental Analysis
These two go hand in hand. You have to perform your fundamental analysis before you invest in any company, but for penny stocks you have to thing about the industry life cycle of the company.
Think about these two companies:
Traded at a high of $143.76 in 2011, however fell to $0.16 and declared bankruptcy in 2015.
Trading at $1 per share in 2008 and skyrocketed to $10 per share by 2009 where it is remained until 2020.
The difference between these two companies are the fundamentals. Walter Energy founded in 1946 and supplied metallurgical coal, soon found in the 21st century that it was in a dying industry due to the public and political movements. So in a downward life cycle, the company couldn’t afford to remodel the business, and hence died with the industry.
By contrast, Inovio is a biotech company and play a strong role with partners in its cancer vaccine portfolio, which shows strong buyout potential. The company is in a thriving sector and is on the growth portion of its life cycle.
When it comes to penny stocks you should look at these main factors when doing your fundamental analysis:
- Company Debt: Can the company sustain short term liabilities?
- Cash Flow: Is the company is a position to reinvest earnings into growth?
- Buyout Potential: Does the company have the potential to form partnership with a larger company either through product collaboration or patent buying?
- Competition: Does the company have power over its product or service either through patents, or lack of substitutes?
Finally the industry life cycle… There are 4 main steps in the life cycle of a company:
- Pioneering Phase: The company is in its infancy and looking to increase market share through innovation
- Growth Phase: The company is sustaining growth through general day to day activities.
- Sustained Phase: The company is at its peak performance and can continue this level of output without further innovation.
- Crash Phase: The company is no longer innovating and making new products/services, public demand for prior products has decreased and the company is beginning to fail.
When investing in penny stocks we are typically looking for companies in the Growth Phase. During the Pioneering Phase, there are too many unknowns, and we can’t be sure the company will become organised enough to sustain growth. Also during the last 2 phases, the company is at its peak and we don’t expect it to grow anymore, unless it develops new revenue streams.
A company can go back up the cycle, once a company has reached the Sustained Phase, company owners might look to maintain this level. However in recent companies like Apple, Microsoft, and IBM, once they hit a plato, the companies go back to innovation and hence dive back into the Pioneering Phase. Only when the new product/service is tested and demand is high, do they then go back to the Growth Phase.
IBM is particularly interesting, as they have changes sectors in the tech world over the last 10 months. Once a stagnant company on the way to the Crash Phase. They have innovated and gotten themselves into the new industry of cloud computing. Hopefully they will continue to do well and we will see them head back into the Growth Phase.
Determining which phase a company is in will come with experience, it is a judgement call and only you can make it. Just think about public demand, any new product developments, and the authority the company has in the industry.
Why Penny Stocks are Risky
Penny stocks are considered risky because the price is easily manipulated and the companies are not stable companies with long histories.
But if you can get over the fear of penny stocks and test the waters out, you could find that tiny 1 in a million beverage company, that turns into the next Monster Beverage giant.