Great penny stock indicator #1 –Profit
The first thing I look at is a company’s profit. If there’s no profit, or no profit prospects it’s certainly not worth your time.
The easiest questions to ask when looking at ‘Profit’ is:
1. Does the business have significantly more profits than interest to pay on debt?
2. Is the business growing profit,or is there prospects for growing profit in the not too distant future/
3. Are profit margins improving?
4. Does the company generate returns on equity in excess of 10%
5. Are profits backed by cashflow or is the company increasing sales on the back of aggressive credit extension?
Answering all these questions will give you an idea about the quality of a company’s profit and how well it can weather a storm. It will also give you an idea about future growth prospects.
Great penny stock indicator #2 –People
Management is extremely important for all companies, particularly smaller ones. Management can make or break a company.
The easiest questions to ask when assessing management is:
1. Does the CEO demonstrate passion? Go to a results presentation and see whether the CEO is excited about what he’s doing or is he merely there to pay the mortgage?
2. Does the management team have a long term vision? Check the company’s annual report. Is there metrics in there to measure success over the long term? Does management speak about a plan or strategy?
3. Does management have skin in the game? I like it when management owns shares in the companies I invest in. It means they also have something to lose.
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Great penny stock indicator #3 – Potential
In my Red Hot Penny Shares
newsletters I refer to this item as the Wow Factor!
What is the single most attractive thing about this company?
Ask yourself these questions:
1. Is the company in a fast growing industry?
2. Is the company growing market share quickly?
3. Does this business have a strong competitive advantage over competition?
4. Is the share price really attractive?
You need to get positive answers on at least two of these four questions. Only then will you know this is a share with the potential to really WOW you!
Great penny stock indicator #4 – Valuation
No matter how great a business is, a major portion of the profits you make from investing in it comes from the price you pay when you buy.
Knowing when a share is undervalued isn’t that difficult – knowing when it is undervalued for a reason though can be tougher. That’s why this item is last on the list. If you’ve answered the questions for the previous three indicators and it’s come out positive a cheap company is just cheap, and not cheap because it is bad quality.
Things to look out for in undervalued companies:
1. Is the share on a lower PE ratio as the JSE All-Share Index average?
2. Is the one year forward PE ratio lower than the average PE for the sector the company is in?
3. Are you over- or underpaying for assets? You don’t want to pay multiples like 5x net asset value for share…
4. Does the company have a significant stash of cash in the bank or is it living off debt?
Follow these four indicators and the questions I’ve listed with them and you’re sure to uncover quality penny shares with big profit potential!
Here’s to unleashing real
Editor, Red Hot Penny Shares