How to Choose the WinnersUnderstanding Penny Stocks

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Secondary Fundamental Considerations

Market Risk

It is often difficult, though not impossible, to make money in a downward spiraling market. Of course, it is much easier to bring in the profits when the stock exchanges are roaring along. Just like tides throw the fish around, stocks are inevitably going to be tossed about by the market.

Always remember to compare your success (or lack thereof) to the performance of the markets themselves. Gaining a 5% return in a year that the markets lose 15% is pretty good, even if it does not appear so on your account statement.

Industry Risk

Every sector of the economy has its own influences. The steel industry is affected significantly by steel prices. Companies based in Texas are affected by laws and regulations that apply in Texas. Defense technology companies are moved by changes in Federal defense budgets.

You need to know the potential risks (and benefits) that affect the underlying stock you are interested in. You also need to know the sub-sectors that the companies you like fall into.

For example, a company may be in the diamond exploration sector, and be ruled by all the subsequent market influences, but it may also be listed on the NASDAQ SmallCap market, with a head office in California, and have most of its operations based in South Africa. That company will then feel the influences of changes in NASDAQ SmallCap listing requirements, new rules imposed by California's governing body, and factors that impact the South African diamond exploration business.

Legal Action and Law Suits

Nothing takes the wind out of the sails of a company, especially a penny stock corporation with a small market capitalization, like being on the wrong end of a law suit. It can cause anything from distraction to destruction, and the uncertainty that goes along with it inevitably causes damage to the share price.

While you can usually find out ahead of time which companies have an existing law suit against them, it is nearly impossible to predict future lawsuits. Even the corporations that get sued do not necessarily know they are going to get sued, so there is no way that an outsider can know ahead of time. For this reason, all I will say on the matter is to factor existing law suits into your company analysis, and do not really worry about unexpected ones beyond that.

Of course, sometimes looming lawsuits can help you get involved in a penny stock for much less than you would otherwise have to pay. When Navarre (NAVR) had a law suit against them thrown out, it helped share prices spike higher. The uncertainty around the litigation had held shares down so long that the response to the dismissal was very strong.

Competition

New competitors, especially those backed by cash-rich mega-corporations, are often a bad sign for penny stock companies. On the other hand, the failure or disappearance of a competitor will have tremendous benefits in both the short and long-term.

Look for those penny stocks that have claimed and perfected their own niche, and enjoy customer loyalty. There may be a lot of computer manufacturers, but for many years Paravant Computers (PVAT - NASDAQ) solidified its niche by selling rugged laptops and war games hardware to the military. While no other company could outdo them in their own niche, Paravant enjoyed excellent earnings and market growth, even while their major, well-known competitors lost money going head-to-head in the personal computer business.

Management or Board Changes

Changes in the key personnel can be a good sign or a bad sign. When the company is floundering and needs new direction, bringing on experienced individuals to fill the major roles can often improve the operations of the company.

If the CEO and founder of the corporation, and the only one who really knows how their widget works, suddenly jumps ship, you may want to examine the reasons why, as well as the potential implications.

In either case, such moves do not always impact the share price in the near term. Much of the time investors grade the new management by their results, and give them a chance to prove themselves.

You have now been introduced to the first half of Leeds Analysis. Using the fundamental parameters discussed, you should be able to research any penny stocks you are interested in, and get a pretty good idea of which are the best companies.

Of course, even the best companies are sometimes too expensive. So far, you have found the best penny stock companies. Now, lets get involved in these at the best prices. In the next section, I illustrate some Technical Analysis techniques that you can apply to pick up shares at the low end of their price ranges.

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