Earning Their Copper: Penny Stocks That Are Actually Worth the Pennies

Originally posted on Bullworthy.com.

June 27, 2010

Successful first-time investing is all about learning as much as you can and then applying that knowledge with discipline and practicality. And while that sometimes isn’t even half the battle you’ll likely face ahead, it is probably the first step and will soon be your golden rule if you ignore it and lost money on your first trades. Investing with discipline and practicality means you’re buying what you know, when you know it, and at a price and value that you understand.

Is that too much to swallow in one sentence? I know it probably is, but you’ll have to get used to it. Let’s take this one step at a time and use (what seems to be, at least) a common first-time investors Holy Grail: the penny stock.

A penny stock has undergone many definitions among traders and no one description seems to hold any more validity than the other. Some say a penny stock is any publically-traded stock that trades for under five bucks a share, while other insist trading under a dollar a share is the mandatory criterion. I have to agree with the former argument; when deep recessions hit and stocks tank, many times it’s because one rotten apple spoils the whole fruit basket because even the good apples are considered tainted (consider the big banks of the 2008 financial crisis: Lehman Brothers and Bear Stearns who dramatically failed and brought down with them some smaller banks and thrifts that had no exposure to mortgage lending and investments and therefore weren’t as vulnerable but their shares plunged anyway). In medicine, and as of recent popularity in business and finance, this foul, bad reputation is referred to as “contagion”. My point is this: sometimes a stock trades below five bucks a share without truly being worth anywhere near that little amount when it’s really not the company’s performance at fault, and they shouldn’t be classified as a penny stock.

Another important criterion a publically-traded company must meet with the penny stock label accurately is that it’s traded “over-the-counter” or OTC on obscure, unregulated stock exchanges that are rife with ambiguity and unsureties. The two most major exchanges in which penny stocks are traded are Over the Counter Bulletin Boards (OTCBB) and Pink Sheets. Here’s the difference between the two and after you read you’ll understand why your knowledge and discipline will be so important when deciding whether or not to buy a penny stock. OTCBB is an exchange in which regulation occurs (companies are required to report financial documents, statements, and changes to the SEC and be made available to the public at all times) and typically they feature companies of all sizes who a) don’t meet the listing requirements of major exchanges, including but not limited to a certain stock price or shares outstanding and free trading; or b) are gearing up for major exchange listing.

The Pink Sheets by stark contrast lists companies who are not required to file any public documentation and are under no obligation of regulation. For all the shareholder knows, a Pink Sheets company could be one big Nairobian credit card and identity theft scam (sorry Africa, I’m just so damn tied of those emails.)

Know what it is you’re trading. Enough said about discipline for now.

Practicality means doing some homework. If you’ve found a penny stock company that you think has a unique idea and could gain some attention, do some homework! These are publically-traded companies; that means any and all information (within reason, and after its public release of course) is available for you to know.

The majority of penny stock companies are new and small companies that have a ton of debt and not much revenue because there are in that start-up phase. So by that very nature, their share prices tend to be very volatile and don’t trade very often, meaning that if a big number of shares traded in a transaction one day in relation to how many shares are outstanding and available to purchase, there is a huge price swing whether it be up or down. Another investor buying ten thousand shares of a fifteen cent stock could send the share price up five hundred percent in a day (I’ll talk more about why penny stocks move up and down and the factors that contribute to those swings in a later post next week that includes why they can also be dangerous and unforgiving).

Expecting a four-thousand percent return on a penny stock you just read about on a YahooFinance bulletin board? Great! Let me know about it, so I can avoid buying it.

Here’s the bottom line. If you found a penny stock you really want to buy because you think it could explode, then stop for a second and consider this: is there really anything interesting about this company? Where’s the story and where is the proof? If you can’t come up with much, it’s hyped. Here’s an example of an interesting company who’s executive board I recently met and talked to.

Janel World Trade* has been a logistics and transportation services company since the 1970’s, shipping all over the world for its clients and has gained exceptional accreditation in its business, most notably into China. In 2007, an environmental organization approached Janel to help them ship six hundred containers to a heavily polluted and contaminated lake in a Chinese providence called Lake Tai, a huge body of water that supplied water to millions of people in many towns and two major cities: Shanghai and Wuxi. The containers held an anti algaecide solution called Clear Blue 104 the environmentalists had been contracted to distribute but were having issues clearing the requisite permits with the local Chinese authorities. Soon, the group had lost the contract to deliver Clear Blue, creating an opportunity for Janel to step in and take over by using their government contacts, knowledge, and experience. The company eventually landed a United States Trade Authority grant to test the solution in live lake conditions, a grant from a U.S. government agency that obviously has big interests in building trade around China. The initial testing has gone well and the next step is to actually implement the solution into Lake Tai. Should this all go according to Janel’s plan, there are hundreds of other lakes (and millions more dollars that will be committed to Janel) that can be taken advantage of, brining in a whole new vertical business to the company’s corporate and operational structure and new streams of dependable, high profit margin revenue.

And what if Janel does not get follow on contracts immediately? Because Janel is such an unknown and under followed company, there has been no value placed on the potential for large high profit contracts in the water pollution remediation sector. Janel, which did $71 million in logistics business last year, is trading at a very low market capitalization of $8.8 million (remember that “market cap” is calculated by taking the amount of shares outstanding (available) and multiplying that by the stock price – loosely defined, its a way to value a companies worth). When Janel gets noticed by more investors, this valuation could easily rise to a more reasonable multiple of sales. In the second quarter of 2010, Janel announced record-high revenue increases of about twelve percent at $20 million dollars in only three months. Janel’s stock trades under the symbol JLWT for just $.40 per share.

Price-to-sales is another fundamental business valuation (PSR) that pegs a stock to it’s performance history or to that of other stocks. PSR is calculated by dividing the share price by the revenue per share. Most small, un-traded, and unnoticed stocks like Janel have little or no revenue, much less $71 million.

So what about Janel? IT’s tremendously low; in fact a PSR of just one times sales, a modest estimation, would put JLWT (on last year’s revenues and no contribution from Chinese environmental contracts) at a price of $2.00/share. Now there is a penny stock worth its copper.

As always, post your comments, questions or concerns or email tom@bullworthy.com.

*I have received absolutely no cash or any form of compensation from Janel World Trade before, during, or after writing this article.