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How To Find Penny Stocks To Buy


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Penny Stocks To Buy

penny stock to buyTo a new investor finding penny stocks to buy may seem like blindly throwing darts and trying to hit a bulls eye. Even experienced investors can have trouble picking penny stocks to buy. I’m going to share the methods I use to analyze businesses and find penny stocks to buy.

Over the past few months I have been making penny stock picks in a variety of industries and have had a 75% success rate. Here is an article I wrote back in June on hot penny stocks of 2013 currently 3/4 predictions were correct providing sizable gains for anyone who took this advice. The following chart represents the outcome from those picks:
 
 

penny stocks to buy

So how did I pick these stocks?

A Twist on the Value Investing Approach

value investing penny stocks to buyI consider myself a value investor. When I was in college most of the books I read were written by Warren Buffet, Benjamin Graham and David Dodd. After graduating college I spent 3 years as a Valuation Analyst. My job was to value private businesses for estate & gift tax, corporate finance, and litigation support. My financial background was based on valuing private businesses and trying to assign a “public company” price to its shares. My work as a valuation analyst has definitely influenced my strategy as an investor.

As a valuation analyst you have 3 approaches to determine fair value of a business. These are the cost (asset approach), income approach, and the market approach. Since public companies already have market determined share prices we can throw the market approach out (for the purposes of this article). Like Warren Buffet, I also look into management after I have thoroughly investigated the financial statements. In fact, management risk (key personnel risk) is an important factor in determining fair value of private business as well! While it may be hard to find a traditional “value” penny stock, I like to find businesses that are financially sound, have great management, and have a promising future. This approach is a blend of value investing and speculation.

The Approach to Finding Penny Stocks to Buy

Identifying Opportunities

The first step to purchasing any stock is to narrow down a list of potentials. Could your portfolio benefit from an addition from a specific industry? Are you bullish on a certain sector? These are the first questions to ask yourself. Diversity is the key to any successful portfolio and when I begin searching for potential stocks to buy the first thing I look at is how well rounded my portfolio is. Once you have identified an industry or sector you want to invest in its time to start selecting penny stocks to buy.

To help find stocks I like to use the Google Stock Screener. Fill out the criteria for the businesses you are interested in pursuing to begin your search. There are plenty of criteria such as market cap, 52 week price change, PE ratio, and much more.

google stock screener penny stocks to buy

1,000 Foot View

1000 foot viewOnce you have a list of at least 5 to 10 stocks you can start to analyze the financial statements of the companies. Before I really take the time to thoroughly analyze a company I like to look at some signals beforehand to make sure it is worthy of my time. I quickly scan the balance sheet, income statement, and statement of cash flows to get a general idea of the company’s financial health, income production and cash generation.

If the company passes the first test I start looking at latest company news. What I’m looking for here is any big developments in their business model, mergers and acquisitions, and pending lawsuits. Basically at this step of the process you are trying to quickly identify if there is anything that could drastically alter the value of the company.

Narrowing Down Penny Stocks to Buy

After you have run the first two tests you should be left with a much smaller list of businesses to evaluate. Generally, before I proceed with the following steps I like to have my list narrowed down to 2 or 3 businesses. Valuing a business intrinsically is a very difficult and tie consuming process and you want to try and weed out as many businesses as you can before you take the time to finely analyze the remaining businesses.

Next, you need to determine which way you are going to value the business. Typically, you would use the asset approach for holding companies and the income approach income generating businesses. To learn how to perform either of these approach’s please visit my Ultimate Guide to Value Investing. This article is a topic for intermediate investors and assumes you have some experience and technical skill for measuring value. For new investors these two approaches can be studied in great length by reading Securities Analysis or The Intelligent Investor. You can also pick up a book on the subject of business valuation.

Note:
Holding companies are businesses that invest in other businesses (stocks), real estate, bonds, treasury securities, and other assets.
Income generating businesses are businesses that operate day to day operations to generate income either by providing a product or service. Most businesses fall under this class.

Management

managementAt this point you have run 3 critical tests (1,000 ft. view, scanning company headlines, and valuation). Assuming you have a business or two left its time to take a peek at the management of the company. This step can often be the toughest for individual investors. Most businesses that are classified as penny stocks will not have a high profile CEO and management team. However, there are many outlets you can use to look at a manager. The best and (probably easiest) way is to perform a simple Google search for the name of the person (if they have a common name you can try attaching the name of the business to the search query). Try to sniff around and see if you can find their resume or any accomplishments they may have had.

Have any luck? Okay, so finding a manager through a Google search wont always return the results you were looking for. Luckily, you can turn to social media as well. Sites like Linked In (especially), Facebook, Google Plus and Twitter are great avenues to try and learn more about a manager. With a little bit of persistence and craftiness you can probably even chat or email them.

When you invest in a business you are putting your money into something that you believe in. Its important to take the time to research management. Private Investors make most of their decision off the management of a business. Unfortunately, unlike a private investor you will not have the ability to groom a manager who is inexperienced. So you must make sure you fully trust this person to effectively run the business and increase the share price. Looking for their resume and accomplishments is a great way to see what this manager has done in the past and if he can successfully lead the business.

Picking a Penny Stock to Buy

You have ran all your tests and you have a stock that made it all the way to the other side. Is this company a good buy? Well you might have found the strongest company that has great leadership, but the market could have already adjusted for that. The final step in choosing a penny stock to buy is picking a price point you are comfortable with. While penny stocks may be cheap they can also be really expensive for what you are getting. Its important to take a look at your intrinsic valuation of the business for this step. Is the share price around or below the intrinsic value?

penny stocks to buy entry pointMost penny stocks have little if any intrinsic value. Which is why a value investment approach isn’t the most common way to measure penny stocks. This is why I have taken a blend of speculation and value investing for my investments in penny stocks.

At this point you have already thoroughly analyzed the business. You (hopefully) understand exactly how they make money and what effect that will have on the company’s share price. In you valuation you want to take the company’s core business model and project what you think the company can earn. This is why the valuation step is so important to me. When I look at a company’s 10k or 10q I am looking for signs of that portray a positive outlook. Looking to see if the company is investing in new equipment, expanding operations, investing in selling and marketing costs and so on will ultimately be the determining factor for your investment.

Take your projections from your valuation and put a value you think the stock could reach if your projections are met. By doing a simple Discounted Cash Flow (DCF) Analysis on earnings you can see if the company is worth an investment based of your requirements for return.

Hopefully, this guide taught you a few ways to become a successful penny stock investor. Some of the approaches I mentioned may be extremely difficult for a new investor that lacks a strong financial background. If you have any questions feel free to leave a comment or reach out to me on social media.

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2 Responses to “How To Find Penny Stocks To Buy”

  1. chitra says:

    Thanks for your great article. As i am beginner to picking a penny stock it is very useful to me.

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