The terms value used in conjunction with penny stocks may seem faintly ridiculous to you when you consider the bad reputation that penny stocks generally seem to have. They are all regarded as suspect with weak balance sheets and little or no sustainable revenue. However, beauty is only in the eye of the beholder and if you train your eye to spot value in penny stocks, you could well be laughing all the way to the bank.
Like all stock valuation, the valuation of penny stocks is partly a science and partly an art. However, a bad stock is quite simply a bad stock regardless of whether it is a penny stock or not. Too much debt, high operating costs, uncompetitive products and services and ineffective marketing all go into the making of a bad stock. The approach to penny stock valuation differs from the valuation of large companies because you must have different objectives.
With large companies, you are looking to benefit from the appreciation in the share price. With penny stocks, you are often looking for candidates that are ripe for acquisition and hoping to get in on the ground floor. Even the prospect of a company in play, regardless of whether the acquisition is completed or not, will bring in larger investors hoping to profit and boost the share price. The trick is to get into the stock before they do.
Here are some valuation criteria that you might find useful:
- Look for improving earnings and a flat stock price. The improvement in earnings as a result of sustainable sales will ensure that the stock is bound to take off at some point in time. This is assuming of course that there are no other negative factors such as high debt and unsustainable costs.
- Look for companies with low debt levels. Many large companies will shy away from acquiring a penny stock company with little or no revenue and a mountain of debt. Large companies may even be tempted to pay a premium for companies with promising business models and low debt
- Find companies that implement share buyback schemes. The effect of a buyback is to reduce the float on the market and thereby increase the value of your existing holding. If the company operates buyback as a long-term strategy, your holding is bound to see a steady appreciation. The flip side of the coin is to avoid companies that are constantly raising capital and diluting the value of your holding just to stay alive.
- Look for penny stock companies with institutional holdings such as mutual fund investments… Not only will this confer respectability on the company but the presence of large shareholders makes company management more accountable. On their part, institutional investors will play an active role in promoting the fortunes of the business and thereby increase the value of their own orderings. Institutional ownership is rare but you should try looking.