A Different Way To Make Money In Penny Stocks

| November 14, 2011 | 0 Comments

You’ve heard the stories.  Maybe it was from a co-worker or a relative, or maybe even from a good friend.  Regardless of who tells the tale, the story is always the same.

Someone other than you hit it big on some small stock no one had ever heard of.

It’s enough to make you pull your hair out in frustration.  Especially, if you’re one of the many millions of investors who play by the rules.  You know what I mean… the rules dreamt up by the big Wall Street investment firms.

They tell you to diversify your portfolio by investing in a number of big blue chip stocks.  They show you fancy research reports by the best analysts on Wall Street.  They quote statistic after statistic on how the big stocks offer growth opportunity with less risk.

Less risk… really?

Let’s say you’ve been a good little investor and followed Wall Street’s advice.  You put hard earned money in to a mutual fund or exchange traded fund that tracks the performance of the S&P 500.  What do you have to show for your efforts?

Not much!

Over the past 10 years, the S&P 500 Index has returned a measly 3.2% per year on average.  And if you account for inflation, your real return has been a giant goose egg.  That’s right, your real return in the S&P 500 Index over the past decade is about 0%!

Buying and holding big blue chips has clearly not been a winning strategy in the new millennium.

One way to supercharge your returns is with a few well chosen penny stocks.  These small companies have potential to soar in value at a moment’s notice.  Hitting just one or two penny stock winners can make a big difference in your long term returns.

Of course, finding a couple of big penny stock winners isn’t as easy as it sounds.  Most penny stocks never make the transition to the big time.  Oh sure, there are hundreds of small companies with great ideas out there, but only a small fraction of them become consistent, money-making ventures.

The key then is identifying which penny stocks have the best potential to provide big returns.

Unfortunately, there’s no simple formula for finding the diamonds in the rough.

Most penny stock investors put their money behind the best sounding stories.  They might invest in a tiny oil exploration company that just obtained access to huge deep sea oil reserves.  Or they might invest in a small technology company that recently bragged about becoming the next Microsoft or Google.

Never mind the company has no revenue, no earnings, and a mountain of debt.  The promise of untold future riches often trumps reason when it comes to investing.  Of course, this isn’t investing… it’s gambling.

But here’s the good news…

You don’t have to blindly throw money at every good story some stock promoter comes up with. With a little due diligence, you can discover penny stock diamonds in the rough on your own. You just have to know what to look for.

Here’s a great example…

Last February, we recommended a relatively unknown penny stock in our Penny Speculator investment advisory service.  We believed the company had great potential even though they’d been struggling financially.  In our humble opinion, this great little company was a textbook turnaround situation.

The company is none other than Pinnacle Data Systems (PNS).

Pinnacle is a market leader in electronics repair, design manufacturing, integrated computer services, and embedded computer products.  To put it plainly, they provide engineering and manufacturing services.

When we started looking at the company in February 2011, it didn’t look all that great.  Previous management had put the company in a hole by focusing on an extremely competitive and low-margin industry… embedded computer products.

The company had posted a string of quarterly losses as a result.  And the stock had plunged from as high as $3.00 per share in 2007 to as lows as $0.30 in 2009.

That’s a 90% drop in value in little more than a year!

But around that time, management made a very important change in the company’s operation.  A number of senior managers were let go.  And the new team began focusing on higher margin business like custom engineering services and product integration.

The result… a surefire loser turned into a potential big winner almost overnight.

And the change was nowhere clearer than in the company’s third quarter 2010 numbers.

You just had to look through the company’s weak revenue number. Yes, revenues actually dropped 10% in that quarter… usually not a good sign. But this case was different.

The company showed a big increase in profitability.  Gross profit surged 42% to $2.2 million.  And gross margins improved from 22% in the same period of 2009 to 36% a year later.  In case you don’t know, a 14 point jump in gross margins is a huge sign of good things to come.

Most importantly, net income increased year over year from a loss of $2.1 million to a profit of $1.7 million.  And earnings climbed from a loss of $0.27 per share to a $0.21 gain.

This quarter was a major turning point for Pinnacle to say the least.

It showed management’s new focus on higher margin businesses was paying off.  And it seemed likely the company’s numbers would continue getting better with each and every quarter.

So how did the trade turn out?

You guessed it… PNS was a huge success for our subscribers.

When we recommended Pinnacle in February 2010, the stock was trading at $1.26 per share.  An extremely low price given the company’s growth outlook.  At that price, the stock was trading at just 5.2x earnings… well below the industry average P/E of 14.3x.

And apparently, we weren’t the only ones who saw the value in PNS.

Just last week, Avnet (AVT) announced they’re going to buy Pinnacle for $22 million or $2.40 per share.  A huge premium to the prior day’s closing price of $1.14.

And it works out to a sweet 90% gain for our subscribers in just 10 months’ time!

This story highlights an important lesson on investing…

Don’t ignore companies that are going through hard times.  Every so often you’ll find one turning things around.  And when they do, their stock prices tend to soar in value.

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Category: Penny Stocks

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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