How to Choose the WinnersUnderstanding Penny Stocks

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Short List Approach

Here is one possible research approach to finding explosive penny stocks.

First, you will need a 'short list' of penny stocks. This list can be one you already have, or you can build a listing yourself by using a stock screener, like those discussed in Chapter Seven.

For example, your list may include 10 stocks recommended by a stock picking service, or 5 biotech companies, or 25 stocks under $1.50 per share that have a daily volume of 30,000 shares or more. It is really up to you, based on your own interests and investment approach.

Then apply the concepts detailed in Leeds Analysis to all the stocks on your list.

You may do this to rank them from best to worst, or to rule some of them out.

You could also use the methodologies to ascertain what the stocks are worth, good entry and exit prices, and how you expect the stocks to perform in the future.

Let's assume you have a list of eight stocks. Compare them as follows

  • Firstly, list your stocks down one column of a page, then list the parameters detailed below (ie-revenues, cash per share, debt...) in a row across that page. (There is an example of this further down).
  • Secondly, rank the stocks in each parameter category, giving them a score from 1 to 8. (1 is best, 8 is worst) If you have six stocks, rank them 1 to 6.
  • Thirdly, add up the total scores to create your list in order of best to worst. (Lowest total score is best)

Any stock that has a major 'warning sign' (or several minor ones) should be removed from consideration.

Cull out the stocks with problems. For example, a company may look great except that it has $2.1 billion in long-term debt. Cross it off the list. A company looks amazing, but there is a major lawsuit against them. Cross it off the list.

There are hundreds of penny stocks out there right now that will be trading much higher in the next few months. Do not settle for a dog. If you insist on the best, you will very often get it.

Also note that just because a penny stock outranks the others on your list does not necessarily mean that it is a good investment. It simply means that it is probably the best from the list. (Perhaps all of the penny stocks on your list are bad). Make sure that you not only find out which are the best investments from the list, but that they are good investments compared to the majority of stocks.

It is not required that you consider all or even most of the following parameters in your research, but the more the better.

Fundamental Analysis ( The Books )

For the following criteria look for a trend from one quarter to the next, going back as far as three years. Also, look at management comments and future expectations to get an estimate of where the company could be going. (Management often make guidance comments in their financial releases).

  • Cash per share
  • Earnings per share
  • Long term debt
  • Revenues
  • Revenues per share
  • Book value
  • Competitive advantages
  • Share buy-back plans
  • News and press releases
  • Financial ratios
  • Competition analysis
  • Market share (current and realistic growth potential)

Technical Analysis ( The Charts )

Not all penny stocks, in fact quite few, present technical patterns. It is in SOME circumstances that a pattern appears. Do not 'force' yourself to find one if it is not obviously evident. Also, do not incorporate TA into your research if you do not understand it.

You are looking for buying opportunities with the TA patterns I have described to you, as opposed to learning whether or not the stock is a good investment. Rank the shares in order of which you feel is in a good buying opportunity, and make a note of the price or range you think would be best to acquire the shares at.

Try to identify the following TA patterns. If a pattern is not present, or you are unable to identify one, make a Not Applicable note to yourself.

  • Dip
  • Collapse
  • Temporary spike
  • Permanent spike
  • Support level
  • Resistance level
  • General range
  • Current trend
  • Trend reversal
  • Topping out
  • Bottoming out
  • Consolidation
  • Volume

Market Analysis ( The Shares )

The following information can illustrate the stock's liquidity and level of investor interest. You can also use some of these parameters in your technical analysis.

  • The market it trades upon (NASDAQ is best, OTC is worst)
  • Shares outstanding
  • Market capitalization
  • Insider ownership
  • Institutional ownership
  • Insider trading
  • Daily trading volume (average)

Thus, a short-list ranking page might look like this. We have listed only three stocks for this example, but generally you may be using 5 to 30.

Short List Fundamental Analysis Rankings
Three biotechs under $1.00 per share
 ABC CorpLMN LtdXYZ Inc
Earnings/Share213
Cash/Share113
Debt Load321
Share Buy-Backs(No) 3(Yes) 1(No) 3
Market Share131
Debt/Equity123
Total:111012

Given the above example, LMN Ltd., with the lowest total score, represents what is likely to be the best choice from the group. However, as the rankings are still quite close in results, you would then use additional criteria and continue your research.

Additional Considerations ( The Situation )

Beyond the above parameters, you need to consider the following.

  • Industry conditions for each stock on the list (current and future)
  • Sub-sector conditions (current and future)
  • Strength of alliances
  • Political and social shifts (realized and likely)
  • Market risk (this will affect most stocks in a similar way)
  • Legal action
  • Management competence and changes thereto
  • The market it trades upon (NASDAQ is best, OTC is worst)
  • Shares outstanding
  • Market capitalization
  • Insider ownership
  • Institutional ownership
  • Insider trading
  • Daily trading volume (average)
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