Good penny stocks offer huge profit potential. Take Monster Beverage Corp. (Nasdaq: MNST) for example. Shares of MNST stock were worth $1.28 in 2004 and zoomed over the $100 mark in 2006 for a gain of more than 7,800% in just two years.
But penny stock investing can also be risky when not done properly. This month's meteoric rise of CYNK Technology Corp. (OTCMKTS: CYNK) stock is the perfect example.
On June 17, CYNK stock was worth just $0.10, but the stock exploded to $21.95 on July 10 - a gain of 21,850% in just over three weeks.
At first glance, that's the type of gain that has investors retiring early.
Hopefully no one actually quit their job though, because CYNK is not the type of penny stock that can really make investors rich.
A closer look reveals that CYNK has no revenue and no assets whatsoever. In fact, the company reported having an operating loss of $1.5 million in 2013. This year, it didn't even file an annual report with the U.S. Securities and Exchange Commission (SEC).
"This is essentially a stock manipulation scam," Yahoo! Finance senior columnist Michael Santoli said. "There really isn't a business here. It's a listed company. You have a lot of these kind of dormant or shell companies that sit on the over-the-counter market."
The company purportedly operates a website, site.introbiz.com, which describes itself as a social marketplace that will provide contact information for business professionals and celebrities for a fee. However, it appears no business is actually taking place.
Now, the SEC has suspended trading on CYNK stock as it investigates the company.
"Any ounce of investigation in terms of what this might have been as an underlying business would have shown you there's nothing to bother owning here," Santoli said in a video interview last week.
That's why research is exactly what it takes to separate the big penny stock winners from the scam companies trying to separate you from your money.
Fortunately, the research doesn't have to be overly complicated. Any investor can pick out the cons using these simple strategies...
Four Ways to Pick Good Penny Stocks and Avoid Scams
No. 1 - Stick to Major Indexes: Many penny stocks trade on the Over-The-Counter Bulletin Board (OTCBB) or on the Pink Sheets, rather than on major indexes like the New York Stock Exchange or the Nasdaq. The downside, however, is that the OTC markets and Pink Sheets do not require the same reporting standards for financial information as the NYSE or Nasdaq. Therefore some scam companies do not fully report financial information.
For very conservative penny stock investors, sticking to the major indexes is the best bet. However, that does narrow down the amount of penny stocks quite considerably.
Another option is following the Pink Sheets classification system, which puts penny stocks in the "PremierOX," and "PrimeOX" categories.
PremierOX companies sell for at least $1 per share, have at least 100 shareholders with a minimum of 100 shares each, and meet the requirements of the major exchanges. PrimeOX companies have no minimum share price, but have at least 50 shareholders with 100 shares minimum.
Sticking to those two categories will help weed out scams and shell companies. At the very least, avoid companies that are very illiquid or who don't offer detailed financials. Which brings us to the next strategy...
No. 2 - Do the Proper Research: Researching any investment is important, and when researching penny stocks, you need to know where to look.
The index that the company trades on will provide company information, and that's a good place to start. Check out the OTC markets website and Pink Sheets website for stock information, research reports, and company profiles. Always check the company's own website as well.
Another good step is contacting the company directly and requesting any information available. Most will offer financial and product information to investors. If a company does not provide this information, there is probably a reason why. Be wary.
If the company is located outside of the United States, research the political, economic, and social situations of the country. Also be sure to review the business laws of the country. Frequently, the company will provide this information for investors.
No. 3 - Look for "Ready for Market" or Buyout Candidates: "Many penny stock companies (especially health-related biotechs or innovative technology companies) spend years researching and developing their products," Money Morning's Defense and Tech Specialist Michael Robinson said. "This may include lengthy and rigorous testing. Pharmaceutical biotech products can spend years in trials and tests."
Find companies that are ready to bring major products or medications to market, as they could experience a major catalyst. If a product takes off, the company's stock will frequently do the same.
Buyout candidates also offer a great penny stock opportunity, according to Robinson.
"Many small companies are prime buy-out candidates," Robinson said. "Typically these companies have a market niche, a technology, a promising drug, product (even patents) that a larger competitor desires."
"When one company buys another, they agree on a price. Many times, that price is much higher than where the penny stock is currently trading. This gives those shareholders an instant gain."
Finding a company that's prime for purchase could bring big gains to investors in a short period of time. Robinson suggests following M&A trends to see which industries are the hottest for takeovers.
No. 4 - Invest the Right Amount: Finally, it's important to maintain perspective and only allocate a small portion of your portfolio to the good penny stocks you've identified. Betting on too many long shots is risky, and not a winning strategy. Betting the 50-1 horse every time may result in a winner every once in a while, but it's a foolhardy strategy.
Don't view penny stocks as your lottery ticket, and assess your penny stock investments like you would any other stock. Getting caught up in "what-ifs" instead of calculated research could doom your portfolio.
Do you invest in good penny stocks? What are some of your penny stock investing tips? Join the conversation on Twitter @moneymorning and @KyleAndersonMM using #PennyStocks
One of the best techniques for finding penny stocks to buy is finding industries experiencing tremendous growth. And the good news for investors is that we've found three penny stocks that could profit from two growing industries...