Tips For Finding Winning Penny Stocks

| February 2, 2009 | 0 Comments

The financial industry has produced a number of truisms about the market over the years.  You’ve probably heard at one time or another such famous sayings as:

“Buy low, sell high.”
“Buy the dips.”
“Buy on weakness – sell on strength.”

Market truisms are great because they’re generally true and easy to remember.  You can throw them out in casual conversations and watch your audience nod their heads in agreement.

One truism getting a lot of press these days is about small company stocks.  It goes something like this.

Small company stocks perform better than large company stocks as the economy comes out of a recession.

And, according to the Wall Street Journal, there is evidence to back this up.  In an article from last September, they wrote, “in the 12-month periods following the end of the last nine recessions, small stocks on average provided a 24% gain, compared with 17.6% for the S&P 500.”

That’s a pretty strong argument for having some quality penny stocks in your portfolio.  You don’t want to miss out on the coming rally.  The problem is you can’t wait for proof the recession has ended before buying.

Economists will call an official end to the recession many months after it has already happened.  By that time it’ll be too late.  Penny stocks will have already made a major move upward.

The time is now to selectively add penny stocks to your portfolio.

As an added bonus, you can buy these stocks right now on the cheap.

Institutional investors have been selling small company stocks across the board since last September.  As measured by the Russell 2000 Index (RUT), small company stocks are down almost 38% in the last twelve months.

Anytime you have indiscriminate selling like that the good companies get sold off with the bad.  As a result, many quality penny stocks are trading at huge discounts to their true value.

The question is how do you find them?

Over the years, I’ve found the best performing penny stocks share three important qualities.  I look for these qualities when researching companies for my monthly investment advisory, Penny Stock Breakouts.  As a special favor to Brian, I’ve agreed to share these valuable secrets with our loyal Dynamic Wealth Report readers.

The first thing I look for is revenue growth.

As many of you know, earnings power is an important factor driving a company’s stock price.  However, a company can’t grow its earnings if it’s not growing revenue.  Earnings growth with no accompanying revenue growth is usually an accounting trick (steer clear of these stocks).

I’m looking for companies that consistently grow their revenue faster than the average for their industry.  I’ll look at their revenue growth quarter over quarter and year over year.  Then I’ll compare these figures to the industry growth rate.  The companies growing their revenue faster than the industry average are most likely growing their earnings faster than average as well.

The next thing I look for is earnings growth.

Earnings are important because they are the best measure of a company’s worth.  Companies that make money consistently will see their stock values rise over time.

But, I’m not interested in companies reporting the same old earnings every year.  I want to find companies growing their earnings at a rapid pace.  These stocks make bigger moves in shorter periods of time.

The last thing I do is determine which of these fast growing companies is misvalued by the market.  Even though they have high growth rates, you don’t want to overpay for this growth.  A simple yet effective way to do this is to look at their PEG ratios.

The PEG ratio is calculated by dividing the company’s Price to Earnings (P/E) ratio by its annual EPS growth rate.  A PEG of 1.0 means the stock price fully reflects the company’s earnings potential.  A PEG lower than 1.0 means the stock is misvalued by the market.

For example, let’s assume you’ve found a stock with a P/E of 10 and an earnings growth rate of 20%.  The PEG ratio would be 10/20 or 0.5.  The PEG is less than 1.0 so the stock is misvalued compared to its growth potential.

On the other hand, let’s say you find a stock with a P/E of 20 and a growth rate of 10%.  The PEG ratio would be 20/10 or 2.0.  This stock is trading for 2x its growth rate and is overvalued.

In the long run, you’ll get higher returns by investing in stocks with lower PEG ratios.  Stocks with higher PEG ratios will usually fall to a price that more accurately reflects the company’s earnings growth potential.

As I said before, I’ve used these three simple rules with great success. They’re an important part of my selection strategy for Penny Stock Breakouts.  In fact, using these exact rules, I’ve found stocks that have doubled and tripled since last September (when the market started getting really bad).

Bottom line, you should make these rules a part of your stock picking strategy.  Use them now to find the next big winners in the coming rally for small company stocks.  You won’t be sorry you did.

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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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