Stocks with a trading price at or below $5 a share are called penny stocks. Penny stock issues are usually offered by fledgling companies that need to raise cash to grow their business operations. Many penny stock sites promote these up-and-coming penny stocks as the next Apple or Google. The sites promise big profits fast just for following their trade recommendations. It’s up to the investor to analyze these claims and see if the promoted company warrants an investment or if it’s one to avoid.
Go online to a penny stock site such as the Stock Market Authority, Penny StockLocks or The Penny Stock Investor. Start by gauging the emotional level of the content. Look for comments designed to appeal to a trader’s greed, such as “This stock is set to jump 188 percent in the next few days.” Other tactics target an investor’s fear of losing out on an easy profit: “Did you miss our last stock pick that soared 300 percent?” The inflammatory language targets a trader’s emotions without providing financial information to back up the seller's claims.Step 2
Find the website of the company the penny stock site is promoting. It’s a big red flag if the company being hyped does not have a website. The home page should be designed in a professional manner and not echo the penny stock site's emotional pitch. Go to the financial section and find the current and past quarterly statements and annual reports that have been filed with the Securities and Exchange Commission. Beware if the company has fallen behind with its filings or has not filed at all. If a company hasn't filed financial reports, you won't be able to analyze its health by analyzing liquidity ratios, cash flow statements, debt ratios and price to earnings ratios, among other financial measurements of a company's health.Step 3
Find out if the stock has been highly promoted in the past. Investimonials, Pumps and Dumps and Penny Stock Research are some of the websites that alert investors when a company is being paid to promote a penny stock. Go back to the penny stock site and scroll down to the bottom of the page. The SEC mandates that a penny stock site must disclose if it has been paid to promote the stock and must provide the name of entity paying for the publicity, the amount and type of compensation and how long the stock is being promoted. If the disclosure is there, chances are it’s a “pump and dump” scam designed to run up the stock price so the few who get in on the ground floor can make a nice profit before they sell and the stock price plummets.
- Always check out the company before you invest. Do not take the penny stock site’s promotional material as fact.
- Penny stocks are notoriously volatile. Only invest with money you can afford to lose.
Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.