Checklist to follow while investing in penny stocks

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Highlights

  • Penny stocks are generally issued by companies with lower market capitalisations, and these stocks trade at a low price.
  • Penny stocks are favourable investment options for investors with a limited budget.
  • Penny stocks are very responsive to market fluctuations.

Penny stocks are generally market-traded securities with lower prices. These are mostly issued by companies with lower market capitalisations. Penny stocks are also known as micro-cap stocks, nano-cap stocks and small-cap stocks, depending upon the market capitalisation of the company.

A company’s market capitalisation is calculated based on the current share price and the number of outstanding shares.

Benefits of penny stocks

Risks associated with penny stocks

Penny stocks are generally issued by small and growing companies, which  have limited cash, and resources and this makes  the shares comparatively risky.

Some small enterprises gain access to public investment through penny stocks. These businesses might use this platform as a steppingstone to enter a bigger market. Additionally, there is potential for tremendous upside because they sell at such modest costs. However, a few things make trading or investing in penny stocks more dangerous. Securities typically carry greater risk than blue-chip equities, representing more established businesses.

Therefore, penny stocks are suitable for investors with high risk tolerance.

Volatility – Penny stocks are very responsive to market fluctuations and can rapidly drop to dirt cheap prices. On a penny stock, investors run the risk of losing their entire investment or even more if they buy on margin, which implies they borrowed money from a bank or broker to buy the shares.

Less liquidity – As penny stocks are generally issued by small and less popular companies, there are not more investors willing to buy these stocks. At times of need, it becomes challenging to find a buyer for these stocks.

Lack of information – It is important to have sufficient information about the company's business while investing in any stock. However, it is difficult to find information on the business performance of some penny stocks, making it difficult to make investment decisions.

Lack of history – It is difficult to determine the stock potential of penny stocks as they have limited or no track record at all.

Avoid penny stocks with these properties

  • Penny stocks with high debt
  • Penny stocks that are making a loss
  • Penny stocks with low promoter holding
  • Penny stocks not generating cash flow from operations
  • Penny stocks with high-risk business due to external factors
  • Penny stocks with a higher price

Checklist to be followed

Before investing in penny stocks, one should keep the following things in mind:

Close view of the company's business

Before investing in penny stock, one must conduct due diligence on the company's operations. The company must have strong and innovative products in its pipeline or products/services in the market which are not easily replaceable.

Company's outlook

A company must have a strong outlook despite present operating obstacles. A glance at the earnings and profit guidance can tell a lot about a business. A company must have a steady record of increasing its guidance year-on-year. For instance, if a company's guidance for the next financial year has dropped significantly, it means there is some trouble in the operating or production process within the company or some guidelines or regulations resulting in future headwinds.

Management team

Strong management and leadership play a crucial role in driving the fate of a company. Allocation of assets, reinvesting profits and dealing with external parties depend on the management team. A company run by leaders with strong professional background is likely to flourish in the future owing to their experience and expertise in running a firm smoothly.

Stock performance

One can also screen out worthy penny stocks by looking at their price performance from the last couple of years. If a company's share value has appreciated significantly by five or ten times over a period, it is a good sign of growth, and one can consider pouring money into that stock.

Operating industry

Considering trends and norms of an industry is very important before investing in any stock. For instance, before investing in aviation stocks, certain government policies, anticipated fuel prices, and international travel and tourism updates must be kept in mind.

Management holding in a stock

The company's management and shareholding pattern can be a significant factor in tracking the stock price and its future performance. If the management has a greater part of stock holding, they have good confidence in the business growth. On the contrary, lesser holding by the management team is not a good sign for the stock. 

On this backdrop, we at Kalkine Media® will discuss few stocks from ASX healthcare sector that have made significant price gains in the last three years.

Race Oncology Ltd (ASX:RAC)

Shares of the precision oncology company have rallied by about 2,961.5% in the last three years and is currently trading at AU$2.000. The company has a phase II/III cancer drug called Zantrene for which the company has compelling clinical data according to which Zantrene can be used as chemotherapeutic agent in several cancers.

Cryosite Ltd (ASX:CTE)

Cryosite provides services of logistics, biological storage, and sample management related to clinical trials. Share value of the company appreciate by nearly 1,230.0% in the last three years.

Actinogen Medical Ltd (ASX:ACW)

Actinogen, a biotechnology company is currently developing Xanamem, its lead compound. Xanamem is a promising therapy for Alzheimer’s Disease and depression. Actinogen has rallied by over 908% in the last three years.

CogState Ltd (ASX:CGS)

CogState is a steered by its mission to democratise brain health assessment in clinical research and clinical care. Shares of the neuroscience technology company have provided nearly 857.4% price return to investors in the last three years.

 


 


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