5 Tips For Investing In Penny Stocks
Investing in penny stocks can be a wise move if you know what you’re at – these tips are there to help you.
Tip 1: Purchase Companies That Have Strong Balance Sheets
Just like any other type of equity investment, it is critical to determine what a company’s financial strength is.
Whenever I am looking for stocks to invest in, it doesn’t matter whether the shares cost $500 or $5, I focus only on companies that have strong balance sheets.
When interest rates are on the rise, no debt is a good thing. It isn’t very practical. With penny stocks, that is particularly true, with many of them in their early development stages still.
Here are two major rules:
- Invest only in companies that have long-term debt that is 50% or less of overall shareholder equity. A company with $1 million in total debt, should have at least $2 million in shareholder equity.
- try keeping your penny stock bets on those companies that have long term debt that is less than what their market cap is – the lower it is, the better.
Tip 2: Purchase Profitable Companies
Like all equity investments, it is very important only invest in businesses that are profitable.
There are two different schools of thought regarding this.
On one hand, when you invest in publicly traded companies, whether or not they are penny stocks, it gives you more liquidity compared to private investments. Being able to get out faster justifies taking on higher risk that many investors are willing to accept in order to have the chance to generate large gains in the future.
Private investments, on the other hand, do have longer term holding periods that are built in. Frequently, 3 to 5 years or longer – which means that investors are more concerned with growth than short term profitability.
It comes down to how well you can handle uncertainty.
Personally, I am always search for companies that are earning money right now. Anything less than that is pure speculation. There isn’t anything wrong with taking that kind of an approach. But it isn’t coming that should be considered by novice investors. Here is a good guide on how to find penny stocks.
Tip 3: Thoroughly Understand the Business
Just like all equity investments, it is critical for you to have a thorough understand of the business you are investing in.
There is saying that states that if you are unable to explain what business a company does in a few sentences then you probably should not invest in it.
Imagine you are explaining the investment to one of your children who is in elementary school. Describing what Coca-Cola does is very easy: it is a company that makes soda pop. It is too hard to describe the type of business that Bio-Techne is engaged in.
Stick with what you understand and know. When it comes to smaller-capitalized stocks that is especially true.
Tip 4: Diversify
Like all equity investments, it is critical that your penny stocks are diversified.
So what is a good number of penny stocks to own? No matter how small or big of an investment you want to make, this is the million dollar question.
Some professional investors think you need a concentrated portfolio containing your best picks- 10 to 20 say – while others believe your bet should be spread much wide over 100 or more stocks.
It is definitely subjective.
You do want to be in, at minimum, three to four sectors of the economy that are growing and healthy.
Given the fact that penny stock can have significantly higher risk/reward compared to large-cap stocks like Coca-Cola, it is even more important that your investments be diversified.
Tip 5: Only Risk What You Can Actually Afford To Lose
Equity investments do not come with any guarantees. It is critical that you understand that and you only risk money you can actually afford to lose.
If you have a child headed for college in a few years and the funds that you have set aside for investment purposes will pay her or his tuition, you want to keep those funds invested in something that is more stable.