On the surface, investing in penny stocks seems pretty easy. After all, how hard can it be for a stock trading at $1.00 to double to $2.00? Math is math. And for a company to legitimately double in price, it has to do something pretty spectacular. It doesn’t matter if it’s trading for $1.00 per share or $100.00 per share.
Unfortunately, many investors think stocks that appear cheap are an easy way to make quick money. Until recently, investors could sell on news and buy on dips. With the S&P 500 and Dow Jones Industrial Average deep into the red this year, it’s getting more and more difficult to find undervalued stocks with great short- and long-term growth potential.
With the global markets in turmoil and the fragile stock market seriously overvalued, investors are searching for overlooked, out-of-the-way stocks to beef up their investing portfolio.
But you can’t judge a stock based solely on the share price. Or rather, you shouldn’t. That goes for penny stocks and global behemoths. When it comes to investing in penny stocks, you need to look for well-run, financially solid companies with great products or services that irrational investors have punished unfairly.
On the heels of Black Monday, the recent stock market correction has opened up the door to some great opportunities.
What Are Penny Stocks?
You can thank inflation for ruining a perfectly easy-to-understand term like “penny stocks.” Where penny stocks used to define equities trading for under $1.00, today, a penny stock can be defined as a company trading under $5.00 a share. Some even elevate the term “penny stock” to mean a company trading for under $10.00 per share.
Regardless of their share price or market cap, most people tend to shun penny stocks; for no real reason other than the fact they’re told to avoid penny stocks. Maybe it’s because investors don’t like to do their own due diligence or would rather listen to a talking head on TV tell them what to invest in.
It’s easier to take no responsibility for what you invest in, I suppose. Though investing in what someone else tells you to invest in can be costly, no matter what the underlying share is trading at.
That hasn’t stopped our friends at the Securities and Exchange Commission from warning us about penny stocks, observing that, “investors in penny stocks should be prepared for the possibility that they may lose their whole investment.”
It’s true. You can lose all your money on penny stocks. You can also lose all your money in much larger stocks. I imagine there were a lot of people sleeping soundly at night knowing their hard-earned money was safe in the hands of Lehman Brothers, Nortel, and Enron.
What to Look for in a Penny Stock
Sometimes, like in 2008 and, to a lesser extent, on Black Monday, the market is irrational and investors run for the exits; sending once-sound stocks over the precipice and into penny stock territory.
Case in point; after the markets crashed and bottomed in March 2009, many once-sound stocks fell with relative ease into penny stock territory. Ford Motor Co.’s (NYSE:F) share price tumbled to under $1.00 in 2008. It has since rebounded.
A stock that tracks the wealth of America’s elite, Sotheby’s (NYSE:BID) tumbled to the $5.00 range in early 2009. It too, like the wealth of America’s top one percent, has enjoyed the six-year bull-run.
Admittedly, Ford and Sotheby’s are not your typical rags-to-riches penny stock stories.
But, it does show how a well-run stock beaten down by investors can lead to massive gains. The point is; you can’t just cast a stock aside because it falls under the definition of a penny stock.
Moreover, you should most definitely avoid 98% of all penny stocks. Most penny stocks are penny stocks because they deserve to be. And in this economic climate, investors should be wary of most penny stocks. Why? If you’re looking for stocks with great long-term growth potential, you have to ask yourself what’s wrong with a company that is still a penny stock after six years into a bull market.
So, what should you look for in a penny stock? Pretty much the same thing you would with a small, medium, and large-cap stock. If a penny stock has the following characteristics, it may be an undervalued equity with room to grow.
For starters, look at the company’s fundamentals and technical indicators. A fundamental analysis looks at a company’s financial statements in an effort to predict a trend. That includes looking at quarterly results, cash flow, and debt levels. Is their market share growing in an expanding market? Is the company’s revenue growing, and is it profitable? Does it have a solid management team?
A technical analysis of a penny stock considers chart patterns and past price performance to predict future price moves. Popular technical indicators include moving averages, price data (open, high, low, close), MACD (moving average convergence/divergence), and relative strength index (RSI).
It’s impossible to predict where the markets are heading. That’s why it’s important to know what you’re looking for when searching for undervalued penny stocks. Because if it’s a solid penny stock with great potential today, it will be the day investors run for cover sending the broader markets down. And if irrational investors do pummel great stocks, it opens up the window for additional growth opportunities.
For the sake of this article, a penny stock is any equity trading under $10.00 per share.
3 Penny Stocks to Watch in the Post Black Monday World
Rite Aid Corporation (NYSE:RAD)
We’re #1! On the East Coast. Rite Aide Corporation (NYSE:RAD), with approximately 4,600 stores in 31 states and the District of Columbia, is the largest drugstore chain on the East Coast and the third-largest in the United States. The company sells staples such as prescription drugs, health and beauty aids, convenience foods, greeting cards, and 3,000 Rite Aid brand private-label products.
The company announced that first-quarter revenue for fiscal 2016 (ended May 30, 2015) increased 2.8% year-over-year to $6.6 billion. Same-store sales for the quarter increased 2.9% over the prior year, consisting of a 0.6% increase in front-end sales and a 3.9% increase in pharmacy sales. Net income was $18.8 million or $0.02 per share while adjusted EBITDA was $299.3 million, or 4.5% of revenues. (Source: Riteaide.com, September 8, 2015.)
Currently trading near $8.25 per share, Rite Aide is trading up 28% year-over-year and eight percent year-to-date. The S&P 500, on the other hand, is down 1.8% year-over-year and 4.8% year-to-date.
Zix Corporation (NASDAQ:ZIXI)
The SEC might warn investors to stay away from penny stocks, but that doesn’t stop it from having them as customers. Zix Corporation (NASDAQ:ZIXI) provides industry-leading e-mail encryption, data loss prevention, and transmission services. Its technology enables users to transmit encrypted e-mail and documents to any address in the world.
The company has tens of millions of members and is growing by 100,000+ members each week. Customers include federal financial regulators, divisions of the U.S. Treasury, the SEC, more than 20 state regulators, one in four U.S. banks, and one in five U.S. hospitals. (Source: zixcorp.com, September 8, 2015.)
In July, Zix announced that first-quarter revenue increased 5.4% year-over-year to $13.3 million, while net income was up 14.1% at $1.0 million, or $0.02 per share. It also announced that total orders increased 10.6% to a record $17.4 million. Ending backlog of $73.9 million represents an increase of 8.1% year-over-year and the company’s 13th consecutive quarterly record in backlog. (Source: Zixcorp.com, September 8, 2015.)
During the quarter, the company announced a $15.0 million share repurchase program and that the first of two products to be released in 2015 as part of ZixCorp’s new partnership with Cisco was made available through the Cisco sales and reseller channels.
Currently trading at $4.64 per share, the company’s share price is up 28.8% year-to-date and up 13% since Black Monday. To get to its pre-Black Monday level, the company’s share price needs to climb and additional 3.55%.
Codexis, Inc. (NASDAQ:CDXS)
Codexis, Inc. (NASDAQ:CDXS) is a leading developer of biocatalysts used in the pharmaceutical, fine chemicals, agrochemicals, food ingredients, detergents and biofuels industries. That means they manufacture chemicals that are easy on the environment. Shell accounts for the majority of its sales. The company is also working on ways to manage emissions from coal-fired plants and treat wastewater.
On August 3rd, the company announced the signing of a technology agreement with Merck & Co. Inc. (NYSE:MRK). This marks the second agreement between Codexis and a major pharmaceutical company. Codexis received $5.0 million on the signing of the agreement and is eligible to receive an additional $13.0 million subject to certain transfer milestones. (Source: Codexis.com, September 8, 2015.)
On August 11, the company announced that it entered into a collaborative research and development agreement with a leading global biopharmaceutical company. The company received a $1.0 million upfront payment and could receive additional payments following the completion of two development stages. (Source: Codexis.com, September 8, 2015.)
While Codexis’s share price is down six percent year-to-date, it is up 26% since the beginning of August.