Before offering investors some basic tips on how to buy penny stocks, definition of terms is in order. What
is a penny stock? The general definition is that a penny stock is any stock with a share price below one dollar.
Typically, though not necessarily, penny stocks are associated with companies with smaller market caps. However, a penny stock with an extremely large share count may not fit the description of a “small-cap stock” (at least not in Canada). That said, when someone asks the question “how do I buy penny stocks?”, it generally implies answering a different question: how to invest in small-cap stocks.
Investing in penny stocks/small-cap companies differs significantly from investing in large-cap companies. Because many penny stocks are still emerging companies, a significant percentage of these companies may not even have established revenue streams let alone corporate profits. This means that measurements like “earnings per share” (EPS) often have little significance for these smaller companies.
While investors in larger companies are typically looking for strong earnings (and very possibly some sort of dividend), investors in penny stocks need to focus on other parameters. Growth potential is obviously of primary importance since without solid growth these smaller companies are unlikely to ever produce actual earnings.
Investors will also be very interested in the cash position and “burn rates” for such companies. This is of critical importance in determining how often (and how soon) a particular company may be expected to raise more capital. Since raising capital (typically via an equity offering) generates shareholder dilution, savvy investors will be very aware of these companies’ need for capital.
Obviously, investing in smaller, less-established companies also normally implies a significantly higher level of risk versus investing in larger corporations. The growth plans of these smaller companies may not play out as expected. Also, smaller companies are typically more sensitive to current market conditions.
For this reason, experienced investors who choose to invest in penny stocks will almost always hold a basket of such companies – diversifying risk through spreading out investing capital between a number of different companies. With less balance sheet metrics to use for guidance, investors will often have to broaden their due diligence before feeling comfortable taking a position in such companies.
In 2018, two of the leading penny stocks in Canada (by trading volume) that traded on the TSX-V Exchange were
Antibe Therapeutics Inc (
TSX: V.ATE) and
Pacton Gold Inc (
TSX: V.PAC).
For more info on small cap, micro cap, and Canadian stocks, including tips on how to invest, check out the Small Cap Trending News hub on Stockhouse.