Penny Stock Pros and Cons

I keep running into emails and popup ads about penny stock millionaires investing in  micro cap "picks" and earning incredible returns in a very short time. It seems easy--spend a bit, make a lot, but is it too good to be true?

Weeding Out the Good Picks

Micro cap or "penny" stocks are defined as shares in companies with a market capitalization of under $250 million. Some of these companies are venture miners or start-up internet projects, others are well-established small companies with real income, real sales and real customers. Others have been identified as scams built to simply create an investment and scam their investors.

So, how to weed out the good from the bad? What are the pros and cons of penny stock investing.

Micro Cap Stocks Outperform

There are some very strong reasons why an aggressive investor would choose these microcap companies as a serious investment strategy.  Over the last decade, micro cap and small cap stocks have outperformed the larger entrenched higher priced blue chip companies, especially in recessionary times or during the earlier stages of recovery.

When micro caps stocks take off, they tend to rise very quickly, doubling or even tripling in a matter of hours or days. They cost less, so more shares can be purchased to earn more return on investment.

Penny Stock Newsletter Services and Marketing Reports

Microcap companies often employ newsletter services and other marketing techniques to promote their stock to investors which creates an environment of hype and increased interest in the stock which then sends the price higher rather quickly. These same newsletters often provide in-depth coverage of the micro cap companies which help investors better understand their structure, focus, direction and financial status.

Not for the Risk Averse Investor

These stocks are volatile and often trade on limited volume making them very risky investments. It's sometimes difficult to gather accurate unbiased research on the company or to know if the business is a legitimate.  Some of these companies are venture projects with no clearly marketable product as yet and of questionable financial status.

How to Sift Through Penny Stock Jungle

Penny stocks trade less on fundamentals and more on sentiment. A hyped stock may spring up as the "next big thing" only to drop dramatically a mere hours or days after the spike as day traders and scalpers take profits. Some newsletter services may not be considered reliable and simply act as a marketing service to hype a stock in order to drive its price up for short term investment profit.

Choose penny stock advice from recognized well-established sources that offer other larger stock investment ideas, strategies and have been in business for several years, preferably quoted by other reliable sources.

Don't invest in penny stocks if you don't have the risk tolerance required. Your investment dollars can disappear as quickly as you earn it. Investing in a sleepy portfolio of index funds would certainly be safer.

Apply the same due diligence to these stock choices that you do to a regular investment. Pass the stock through your technical analysis software, consult your financial advisor, and look carefully at the company fundamentals including market capitalization, trading volumes and length of time in business. Does the stock seem to follow the underlying index or is a confusing mess of high and lows with no apparent definable pattern that correlates with anything other than wind direction.

Places to Search for Micro Cap Ideas

Here are some places to find investing ideas which include both well established mid and large cap stocks as well as well-researched and trusted small and micro cap investing ideas:

The Canadian Venture Exchange

Pat McKeough's TSI Network

The Motley Fool

And here are some penny stock investment sites that provide various tips, strategies and investing ideas for micro cap stocks:

Canadian Penny Stock Blog

Penny Stock Rumble

MicroCap Canada

Happy Investing!

Disclosure: Microcap stocks comprise approximately 5% of the author's personal investment portfolio.