Due Diligence for Your Penny Stock - dummies

Due Diligence for Your Penny Stock

By Peter Leeds

Due diligence involves assessing timely and reliable information about a penny stock company in order to make judgments about the potential future share price — from which you hope to profit. It stands to reason that the more effective your research, the greater your trading successes should be.

Although research is valuable with any type of investment, it is of paramount importance with penny stocks. That’s because the underlying companies are much smaller and so can be more easily derailed by a lost contract, a single customer leaving them, or a lawsuit, just to name a few of many possible events.

The upside of such sensitivity to events is, of course, that penny stocks can also multiply quickly in price thanks to a single contract win, or by gaining a new customer, or settling a lawsuit.

You won’t find nearly as much information about low-priced shares than you will about higher-valued stocks, and a greater portion of the information you do find will be less reliable or even misleading.

Skim the surface of penny stocks

All stocks are identified by unique ticker symbols, which are sets of letters used to identify individual companies. You can trade any stock just by knowing its ticker symbol, which is even more important to your broker than the company’s name. Tickers generally range in length from one to five letters, depending on the exchange.

Ticker symbols are unique identifiers, expressed by letters, for each stock trading on the markets. For example, AAPL is the ticker for Apple Computers, while WMT represents Wal-Mart. Anheuser-Busch goes with the symbol BUD, which represents its bestselling beer. No two companies have the same ticker symbol. Using unique ticker symbols reduces the chances of investors accidentally trading in the wrong stock.

In some rare cases, such as a merger or corporate name change, companies may request that the stock market change its ticker symbol.

In the case of a bankruptcy, the stock will have a “Q” added to the end of their ticker symbol. Companies that are delinquent in filing their financial results will have an “E” added to the end of their ticker symbol.

Tens of thousands of stocks trade on the various markets, and many of those stocks have similar ticker symbols. Always double-check the symbol to make sure that you buy or sell the shares that you want — and not those with a similar symbol. For example, if you want to buy shares in Ford Motor Company (F), make sure that you don’t accidentally bid on shares of Forward Industries (FORD).

In order to buy or sell a stock, all you actually need to know are:

  • The name of the company: You certainly should know this if you’re thinking about investing!

  • The ticker symbol of the stock: This unique identifier is the most important piece of information your broker will need from you if you want to trade shares in a company.

  • The price per share: You find this by getting a stock quote from your broker or from one of the thousands of free online services. Most quotes are delayed by as much as 15 minutes unless you pay a service or your broker extra to get “real time” quotes. Generally, you only need real-time quotes if you’re an active day trader with a significant portfolio.

Dig a little (or a lot) deeper for your penny stock

To invest successfully in penny stocks, you need to know a lot more than the name, ticker, and price. By digging a little deeper into the company, you can gain a clear picture of the operational strength of a business, understand its branding and marketing strategies, and find and profit from patterns in its trading charts. This more in-depth research generally falls into three distinct categories:

  • Fundamental analysis: As its name suggests, fundamental analysis considers a company’s fundamentals, which include everything from knowing the management team, to looking at the financial results, to reviewing press releases, and to anticipating how these items will play out given the outlook for the company’s industry.

  • Abstract review: An abstract review is a more advanced version of fundamental analysis, which considers the strength of a company’s marketing, branding, and customer loyalty. Few analysts understand or conduct abstract reviews, a surprising fact considering that a company’s success often hinges on the features analyzed by this type of review.

  • Technical analysis: Technical analysis involves studying a stock’s price movement and trading volume over time in order to predict future share price activity.