Is There Such a Thing As a Good Penny Stock?

Penny stocks are not stocks that cost or return pennies. They are less expensive than other stocks on the market, however. These stocks cost less because they are generally newer to the market and riskier.

You can find good penny stocks, but it might take some work. Learn what makes a good penny stock, how you can find one, and what to avoid.

What Are Penny Stocks?

Penny stocks are shares of small companies that have market capitalizations (or "market caps") of less than $300 million. For this reason, they are also called "microcap stocks." If they have less than a $50 million market cap, they are called "nanocap stocks."

Penny stocks can be listed on major exchanges—but many only trade on over-the-counter exchanges. Word-of-mouth marketing and "pumping" (hyping a certain stock) are commonplace in the penny stock market.

There are several factors to consider when looking for a good penny stock that can keep your principal safe and help you find some microcaps that are worth the trouble.

MicroCap Growth and Trading Volume

Penny stocks should have robust earnings growth that trade close to their 52-week highs. If the stock hasn't been trading for one year, you might want to leave it to other investors.

It’s essential to focus on penny stocks that offer a high trading volume—if they're trading over 100,000 shares per session, they may be worth investigating.

Penny Stock Prices

Another good rule of thumb is to only trade in penny stocks with prices over $.50 per share. Stocks that sell for less than that price are highly speculative and generally include companies with no discernible track record of success.

Consequently, you should check the company’s financials before buying a penny stock. If there’s documented proof that the company is making a profit and handling its debts well, the odds of losing money on a penny stock purchase are lower. If they don't publish any financials, you might want to look elsewhere.

Finding a Penny Stock

You can find penny stocks by using a broker's services. Many of the large brokerages offer over-the-counter (OTC) and pink sheet services within their trading accounts. For example, TDAmeritrade provides the ability to enter into trades on penny stocks through its online trading platform.

Track the stocks you choose for a week or so and monitor how they trade. Look for trading volume and volatile share price swings, and determine your best entry price before pulling the trigger on a purchase.

Penny Stock Advertising and Fraud

The microcap market is often used by criminals to solicit funds from unwary investors. They use recent economic trends, natural disasters, or other significant events that can affect finances to target people who are looking to preserve their capital or generate returns.

It's important to note that penny stock issuers don't generally have the capital to be creating marketing campaigns with flashy media, endorsements from stars, or telemarketing. If you're being contacted about a "good performer," it's likely that you're being targeted.

If you are reviewing a penny stock newsletter or similar publication, make sure you read the disclosure notice it should include. This is a mandatory inclusion by the Securities and Exchange Commission (SEC).

Stick to analyzing the company’s financial statements and its history of making money, paying its bills, and being traded by other investors. Those are the key indicators that a penny stock may offer a financial opportunity.

If you cannot find any financial information about a stock or information on the entity that has issued the stocks or media, it is best to file a report with the Financial Regulatory Authority, the SEC, and your state's regulatory authority and leave that particular stock alone.

Facts About Penny Stocks

Here are a few quick facts about penny stocks that might help you decide whether to invest in them or not:

• More penny stocks are traded on an over-the-counter basis (approximately 12,000) than are traded on major exchanges such as the NYSE, NASDAQ, and the American Stock Exchange.
• Penny stocks can trade on other securities exchanges, most notably in foreign stock markets.
• Penny stocks usually represent struggling companies with low cash reserves and no clear path to future success.
• Penny stocks can also be defined as securities owned by private firms, blocked off from public trading.
• Penny stocks don’t usually trade frequently, making them less liquid.
• Penny stocks are highly speculative and are often hard to price accurately.
• The U.S. Securities and Exchange Commission has strict rules on penny stock trading, including written documentation from broker-dealers on the higher relative risk of investing in penny stocks.