Penny stock investing can offer investors triple-digit returns in just a matter of weeks, like when AVEO stock exploded 332% between June 22 and July 10. But before adding any penny stocks to your portfolio this year, it's important to follow our two easy penny stock investing tips.
The 3 Best Strategies for Trading Penny Stocks Today
You see, the penny stock sector is exciting to investors because it provides opportunities for quick returns…
For instance, AVEO Pharmaceuticals Inc. (Nasdaq: AVEO) could have quadrupled your money in less than a month after the company's latest drug announcement. The stock went from $0.73 per share on June 22 to $3.15 per share on July 10 after AVEO's kidney cancer drug was recommended for approval in Europe by the European Medicines Agency (EMA), the EU's equivalent of the U.S. Food and Drug Administration (FDA).
However, some penny stocks can post these triple-digit gains for fraudulent reasons, which can ultimately cause investors to lose money. Back in April, Hongli Clean Energies Technology Corp. (Nasdaq: CETC) stock climbed from $1.90 to $4.63 – a 144% gain – from March 31 to April 7.
But the Nasdaq exchange halted trading on CETC stock on April 7, and now Hongli is the defendant in a class action lawsuit. According to Rosen Law Firm – the investor rights law firm filing the suit – Hongli allegedly misled investors by reporting false financial data.
The suit is on behalf of investors who bought CETC stock between Oct. 13, 2015, and April 7, 2017 – the period in which Hongli allegedly falsified its financials. If Rosen loses the case, the investors who bought in between those dates could possibly lose all of their initial investment.
Cases like Hongli illustrate why it's so important for investors to know the difference between legitimate penny stocks and ones.
And by using these two tips for finding the best penny stocks to invest in, you can ensure you're avoiding scams and investing in companies with real growth potential…
Penny Stock Investing Tip No. 1: Dig into the 10-K Filings
One of the most important documents that all companies are required to disclose is the annual 10-K filing. This is a comprehensive summary submitted to the U.S. Securities and Exchange Commission (SEC) that documents a company's financial health, outlining everything from earnings, revenue, outstanding shares, and company history. Since the SEC is a federal agency, companies that falsify any area of the 10-K can be charged with fraud and possibly have their stock delisted.
Although those sections are important for assessing a firm's profitability, the most important section for penny stocks in particular is the "Executive Compensation" section. This section is typically located in part III of the 10-K and shows how a company's leaders and upper-level executives are paid.
If you see that the executives are being paid mostly in stock options, it shows they're invested in the company's future. Because they're paid in shares of the company, they likely want the company to be profitable so those shares become more valuable over time.
But if you see they're paid in cash instead of options, it shows they're trying to quickly cash in on their company before it goes bankrupt. This is a red flag because it indicates the executives don't have enough faith in the company's financial future to be compensated in shares.
In other words, it's very risky to invest in a company when the company's own executives don't.
While finding quality companies to invest in is important, penny stock investors also need to know how to identify scams…
Penny Stock Investing Tip No. 2: Look Out for Pump-and-Dump Scams
Pump-and-dump scams are when salespeople working for a company aggressively promote and advertise the company's stock. Various ways they do this include distributing promotional pamphlets, cold-calling random people, and emailing spam ads to generate interest in the stock.
The promoters typically tout the stock as an incredible profit opportunity that can make you life-changing amounts of money. For example, Premiere Publishing Group – which climbed to a high of $1 per share in August 2006 before crashing to less than $0.01 per share in August 2007 – falsely hyped its stock by saying it offered returns of "500% or even more," according to Fusion.
This heavy, misleading promotion can entice unknowing investors to buy the stock, thus "pumping up" the share price. Once it gets high enough, the insiders and salespeople promoting the stock "dump" – or sell – their shares at the new inflated price. This sale inevitably sends the stock lower and causes the duped investors to lose money.
Although there are safe penny stock investments out there, investors can avoid these scams by conducting research into these promotional materials. Searching online for news on the company and checking if a stock is trading at suspiciously cheap rates (less than $0.01 per share) are both effective ways to gauge a company's legitimacy.
Money Morning Small-Cap Specialist Sid Riggs understands how difficult that background checking can be, which is why he prefers to do the research for you.
And today he's recommending one of the best small-cap stocks to buy in 2017.
Although Sid's recommendation costs near $12 a share – slightly above the $5 cutoff for penny stocks – it's worth considering for your portfolio. That's because Thomson Reuters analysts project it to rally as much as 35% over the next year, and you can be sure it isn't a scam.
Here's Sid's pick…