Why Hot Penny Stocks Can Be Dangerous If You're Not Careful

Hot penny stocks can bring investors double-digit returns in a short amount of time. For instance, AVEO Pharmaceuticals Inc. (Nasdaq: AVEO) surged 332%, from $0.73 to $3.15, from June 22 to July 10. That means any investor who bought in on June 22 more than quadrupled their initial investment in less than three weeks.

The 3 Best Strategies for Trading Penny Stocks Today

But top-performing penny stocks can also sometimes post big gains for bad reasons.

One example is Hongli Clean Energies Technology Corp. (Nasdaq: CETC), which climbed 144% in just one week, rising from $1.90 on March 31 to $4.63 on April 7. The rally ended abruptly when Nasdaq froze Hongli's trading, and the firm soon became the defendant in a class action lawsuit...

Rosen Law Firm - the investor rights law firm behind the lawsuit - alleges the company misled investors who bought CETC shares between Oct. 13, 2015, and April 7, 2017. During that time, Hongli supposedly falsified undisclosed parts of its financial reports. If Rosen loses the lawsuit, CETC investors could possibly lose some or all of their initial investment.

Cases like Hongli show why it's crucial for potential investors to know if a hot penny stock is legitimate and safe to add to your portfolio.

Here's one of the most important ways to determine the safety and profitability of a penny stock...

1 Way to Assess the Safety and Profitability of Hot Penny Stocks

To figure out if a penny stock is financially safe and profitable, you have to dig into the company's 10-K filing.

A 10-K is annually submitted to the U.S. Securities and Exchange Commission (SEC) and comprehensively summarizes the company's financial health. It outlines everything from the firm's earnings, revenue, outstanding shares, and, most importantly, executive compensation.

hot penny stocksThe "Executive Compensation" section - typically found under part III of the 10-K - is important for our purposes because it shows how the CEO and other upper-level management members are paid. If you're looking into it and see the executives are mostly compensated in stock options, it shows they're dedicated to the firm's growth. After all, their options can only be as valuable as the company's stock price, and that means they need the company to succeed.

But if the executives are paid only in cash, they don't have a stock incentive to make sure the company performs well over the long term. This is a red flag because it indicates the executives may just be looking to cash in on the company before the stock falls to $0 and the firm goes bankrupt.

In summary, if a company's executives aren't invested in its performance, then it might be too risky to invest in. This is one of the easiest ways to determine if a penny stock is right for your portfolio.

But these 10-K filings can be quite intimidating, even though they are a crucial part of researching the best penny stocks to buy. They can be up to 100 pages in length, and they're often written by accountants who use technical language that can be difficult for retail investors to interpret.

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Fortunately, Money Morning Small-Cap Specialist Sid Riggs likes to do this research for our readers.

And Sid - whose April 19 small-cap pick has given Money Morning Members a 31.9% return since then - is recommending another one of the best small-cap stocks to buy in 2017.

Today's pick is a company that develops and sells medical devices. Three of its products received U.S. Food and Drug Administration (FDA) approval between 2010 and 2012 alone; one of these is the first at-home HIV test sold over the counter.

This gives the firm a profitable advantage over other firms trying to sell similar tests. In fact, this edge is largely responsible for the stock's stunning 101.2% rise so far in 2017.

But Sid doesn't see the rally ending anytime soon, due to the firm's reputation for consistently smashing earnings projections...

Over the last four quarters, this medical device company has beaten analysts' expectations by an average of 57.6%.

In other words, Wall Street has repeatedly lowballed its profitability, making now a perfect opportunity to buy in...

This Is One of the Best Stocks to Buy in 2017

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The pick is OraSure Technologies Inc. (Nasdaq: OSUR), which develops medical devices that detect conditions like HCV, HIV, and influenza. The company also sells drug-screening products that can detect narcotics or alcohol in a person's system.

But OraSure's most popular products include its line of portable cryosurgical devices. These let people apply intense cold to lesions, warts, and other spots on the skin to remove the unwanted or infected tissue.

The company has seen a number of its products quickly receive FDA approval in recent years. In 2010 and 2011, the FDA approved OraSure's blood and fingerstick HCV tests, respectively. And in 2012, the company received FDA approval for its in-home HIV test.

According to the OraSure website, it's the first oral fluid, over-the-counter HIV test approved in the United States. That ability to stay ahead of competitors will continue to be a long-term boost to OraSure stock.

In fact, its ability to outperform the market is already showing this year. The OSUR stock price has soared 101.2% so far in 2017, decimating the Dow Jones' 11.4% gain and the Nasdaq Biotechnology Index's 19.8% return. And Sid expects those gains to keep coming as the firm continues to stay ahead of the competition.

The stock has also blown through Thomson Reuters analysts' previous one-year price target of $16, which they projected back in June. OSUR currently trades at $17.66.

Now, those same analysts are raising their price target, and they give OSUR stock an average price target of $19.20 and a high price target of $21 by July 2018. Those would be gains of 8.7% and 18.9%, respectively, from the current price.

However, the company keeps growing while analysts keep underrating it, and that means it's a value buy right now...

Since Q2 2016, OraSure has smashed earnings estimates by an average of 57.6%. During the last quarter of 2016, the firm posted $0.13 earnings per share, exceeding the $0.05 analyst estimate by 160%. It kept that streak going in Q1 2017, when it earned $0.21 per share and beat the $0.18 projection.

The firm is set to report Q2 2017 earnings today, with analysts expecting it to report $0.07 per share. But at the rate it's been beating expectations in the last four earnings reports, OraSure could be poised to do it again this quarter.

"Analysts have almost perennially underestimated the company's potential - something they won't do for long," Sid said. "Which is why you don't want to delay for a New York minute if you're as interested as I am."

With a strong track record of FDA approval and a streak of smashing analyst expectations, OSUR is one of the best small-cap stocks to buy in 2017.

Tiny $6 Million Company Poised for a 28,700% Sales Surge

After an epic legal battle, a tiny $6 million company has just won in a shocking patent verdict.

With 40 registered patents and 500 patents pending, it's positioned to dominate the U.S. medical markets for decades to come. And an imminent announcement could ignite a 28,700% sales surge.

Bill Gates, as well as the billionaires at Google, have loaded up on this tiny company. And Wall Street insiders have boosted their holdings by as much as 2,000%.

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