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How To Make
Big Money In
The Exciting
World Of Penny
Shares
By the Red Hot Penny Shares Team
How To Make Big Money In The Exciting World Of Penny Shares
How To Make
Big Money In
The Exciting
World Of Penny
Shares
By the Red Hot Penny Shares Team
How To Make Big Money In The Exciting World Of Penny Shares
FSP Invest
© Copyright 2011 by Fleet Street Publications (Pty) Ltd.
All rights reserved. No part of this book may be reproduced by any
means or for any reason without the express written consent of the
publisher.
Fleet Street Publications (Pty) Ltd.
Private Bag X16, Northriding 2162.
Registered in South Africa No: 1999/019170/07.
VAT Reg No: 4430185282
ISBN No. 1 899964 69 X
We do try to research all our recommendations and articles thoroughly, but we disclaim all
liability for any inaccuracies or omissions found in this publication. For the purposes of
this publication a ‘penny share’ is a share in a company under R10. Shares are, by their
nature, speculative and can be volatile. Generally, investments in small companies have a
higher risk factor so you should never invest more than you can safely afford as you may
not get back the full amount invested. The difference between the buying and selling price
of small company shares can be significant. The past is not necessarily a guide to future
performance. Before investing, readers should seek professional advice from a stockbroker
or independent financial advisor authorised by the Financial Services Board. Profits from
share dealing may be subject to taxation. Levels and bases of, and reliefs from, taxation are
subject to change.
How To Make Big Money In The Exciting World Of Penny Shares
Contents
Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1: Filter Out The Losers . . . . . . . . . . . . . . . . . . . 7
Part I: The non-financials . . . . . . . . . . . . . . . 8
Part II: The financials . . . . . . . . . . . . . . . . . . 14
2: Valuation: The Final Filter . . . . . . . . . . . . . . 23
3: Special Situations . . . . . . . . . . . . . . . . . . . . . . 31
4: Stop Losses, Profit Taking and Top Slicing . . 35
5: Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
6: Quips, Quotes, Tips and Clips . . . . . . . . . . . . 45
How To Make Big Money In The Exciting World Of Penny Shares
How To Make Big Money In The Exciting World Of Penny Shares
Introduction
A
ny fool can make some money buying shares but, by
following a few simple rules and taking advice from the
right quarters, you can make SERIOUS amounts of money. I’d
like to start by sharing two core attitudes relating to how
individuals treat their money.
Model one works like this: You work for money, give it to the
man in the shop and get some goods. Now you have goods and no
money, so you go to the bank, you get credit and borrow money.
Now you give the bank’s money to the man in the shop and
purchase yet more goods. You have more goods, less than no
money and the stress and depression that goes with it all. If your
finances follow this model, you never gain control of your financial
situation and will end up being a perpetual slave to debt and your
bank manager. Not a pretty picture is it? Yet, this is exactly where
most people end up.
In the second model, you work for money and give the bare
necessity to the man in the shop. You take as much money as you
can and you put it to work for you. Now you’re working for
money and you have money working for you. If you’ve chosen
well and use the power of compounding, it won’t be long before
the money you have working for you, actually overtakes the
money you work for. I’m not suggesting the money you set aside
to work for you should be put in the bank or other low yielding
investments, because the growth is too slow here. You need to
put money to work for you in more adventurous places – like the
stock market. Yes, it’s more risky, but there’s a direct relationship
between risk and reward. No risk… No reward! There’s no better
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How To Make Big Money In The Exciting World Of Penny Shares
place than the stock market to set you on the way to financial
independence…
Our philosophy at Red Hot Penny Shares, however, is you can
substantially increase the gains you make by taking the front seat
and no longer remaining a spectator. There are so many
advantages you, the private investor, hold over institutional fund
managers (the so-called “professionals”). We’ll focus on shares
valued at less than R10. These are generally known as penny
shares, with the orginal term referring to shares under $1 or £1.
This is where the best advantage lies for you as a “guerilla
investor” in the high-flying world of corporate intrigue and
finance.
Your advantage over the “professional”
1. Your biggest asset is you can concentrate your firepower on
the handful of shares that you expect to deliver the greatest
returns. A fund manager would like to do this, but is forced to
invest in a multitude of complex financial instruments, like
derivatives, and in a host of conglomerates that have dozens
of listed subsidiaries (some offshore). The reason is, if he were
to put all his cash into just a few shares, he might well end up
owning them entirely. In other words, he’s forced to invest in
companies in which he only has limited faith. This argument,
that a concentrated portfolio is actually less risky than a
massive one, has been expounded and put into practice over
many years by the greatest living investor, Warren Buffett.
2. Your second-biggest advantage is speed. A fund manager
controls millions of rands and so – especially when dealing in
relatively illiquid smaller company shares – it’s extremely
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difficult for him to buy or sell enough shares to make a
significant difference to the shape and balance of his portfolio.
Remember, a portfolio manager’s remuneration is largely
dependent on the increasing value of his portfolio. For the
private individual, selling or buying a holding that may be
significant to you, but is almost insignificant to the wider
market, should present no such problems. You, and I, can move
in or out of a position almost immediately with no problems.
Why are penny shares great for the private
investor?
Why should I invest in shares in smaller companies, those (for
the purposes of Red Hot Penny Shares) with a market share price
of less than R10 a share?
1. Firstly, the academic evidence is that smaller, younger and
more entrepreneurial companies are expected to deliver rapid
profits and this will inevitably, over the long run, come to be
reflected in the performance of their shares. The most
authoritative academic research on this subject comes from the
London Business School which showed that – except in the
depths of recession – the universe of smaller companies
outperform their larger counterparts every year.
Instinctively, many of us who’ve worked for large bureaucratic
organisations will agree that smaller companies are better focused,
more efficient and organised than their larger counterparts, where
decision-making seems to take an eternity and where length of
service often counts for more than current performance.
2. “Professional” analysts in the broking community often
overlook smaller companies as these don’t generate sufficient
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How To Make Big Money In The Exciting World Of Penny Shares
brokerage. Many of the smaller- cap stocks trade infrequently
and have low share prices. In South Africa, brokerage is
calculated on a percentage basis, so the lower the price, the
lower the commission – to the point where many of the larger
stockbrokers have set minimum limits. For instance, if a
stockbroker facilitates a transaction involving 100,000 Gold
Fields shares at R86.92 a share, the broker will earn about
R86,920 (brokerage fee at 1% of total value), but if he sold
one million shares in a small gold company, Simmer and Jack
Mines at a price of 180c a share, he would earn only R18,000.
The “professionals” would rather write a lengthy note on
Anglo or Gold Fields – even if their research create little
added value – because that report would probably generate far
more commission income than spending the same amount of
time discovering the joys of, and the potential value in,
smaller companies.
That’s how some smaller company shares, with dynamic
growth prospects, can remain unnoticed. Trading in such shares
may be minimal until the company makes a formal stock market
announcement when, belatedly, investors pile in, causing the
shares to soar in value. Even when a formal results
announcement is made, the market may not always realise its full
impact, so there’s often time to buy the share after its initial rerating and still make significant gains.
That isn’t to say that making money from penny shares is easy
because, commensurate with higher rewards, the penny share
sector also comes with higher risks. It’s the aim of the system of
share selection methodology outlined in this booklet and for Red
Hot Penny Shares to steer you away from those risks. Never forget
there are risks.
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How To Make Big Money In The Exciting World Of Penny Shares
Potential problems with penny shares
1. The principal danger (as well as the main attraction) is the
potential gearing of penny shares to just one event. For
instance, if Group Five wins or loses the next big building
contract it could make a difference of, say, 5% to its share
price. For a smaller retail company operating in the same or
similar sphere, just as the potential upside of a big contract
win is enormous, the potential downside from a big contract
loss could be devastating. Careless share selection, when
choosing between JSE Top 40 companies, is unlikely to lose
(or make) you significant amounts of money in relatively few
weeks.
The same isn’t always true for penny shares.
2. The second potential problem with penny shares is one of
marketability, which itself adds to the risk of this game. Not
only can the difference between the buying and selling prices
(the spread) be large in percentage terms, but if there’s also
little trading in the shares, the price can move sharply on
even the smallest trades. This is particularly true for some of
the more illiquid shares.
At Red Hot Penny Shares, we believe you should build up a
portfolio of between eight and ten companies that mirror your
own risk reward profile. If you feel you wish to invest in another
company outside your existing portfolio, you should perhaps
consider realising your gains on one of your current investments
as excessive diversification carries its own risks. You should
always consider banking substantial gains, because every growth
share will, one day, mature to a stage where its rate of growth will
start to decline. A successful penny share investor can have no
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How To Make Big Money In The Exciting World Of Penny Shares
room for sentimental attachments to a particular share, even if
it’s served him exceptionally well in the past. Don’t marry a
share.
Following our system for spotting growth opportunities is a
good start on the journey to making big gains from smaller
company shares. Our monthly publication should assist you on
your travels since it contains research and analysis, available
nowhere else, as well as the distilled insights, views and
suggestions of hundreds of contacts from the markets, industry,
political connections and business dealings.
Remember, not every penny share will be a winner. There are
literally hundreds of shares out there that offer the potential for
making great gains. By using Red Hot Penny Shares’ proven
method and by gaining the best possible sources of information,
you can dramatically increase your chances of picking ‘the next
big winner in the making’ and start creating your own wealth
building portfolio.
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How To Make Big Money In The Exciting World Of Penny Shares
1
Filter Out The Losers
T
here are over 200 penny shares quoted on the Johannesburg
Securities Exchange, in which you could invest in. Each
week various contacts will suggest looking at over 80 shares that
have some potential.
It may sound perverse, but the way to spot the winners from a
given universe of shares is by eliminating all the obvious losers.
That’s Warren Buffett’s strategy: He’ll always look at the
downside of any prospective investment and, if it looks too risky,
he’ll walk away, however tempting the upside. As he puts it:
“Rule number one of investment is not to lose money. Rule
number two is to remember rule number one”.
The Red Hot Penny Shares’ filter method of share selection
comes in two parts – non-financial and financial. In other words,
we’ll first look at all the issues outside of the actual financial
results, like management’s track record and industry
characteristics and trends to determine if the company has the
right profile for our purposes. We’ll then take a magnifying glass
to the results and try to read between the lines to determine if it
has what it takes to be a winner.
Both filters are based on commonsense and experience,
although the second filter will require some financial
understanding. These are qualities that should always be the basis
for all investment decisions, but are too often ignored in the hype
one hears from certain stockbrokers.
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How To Make Big Money In The Exciting World Of Penny Shares
Part I: The non-financials
“Despite my appreciation of structural models in forecasting, I do
not believe in mechanical model-based forecasting, estimating the
model and letting it make the forecast without intervention of the
forecaster.” (Laurence Meyer, Member of the Board of the US
Federal Reserve, 1998)
1. Management is crucial
• Firstly, it must be committed in a financial sense to growing
the business and so rewarding shareholders, rather than
rewarding itself.
• It’s always heartening to see the board has a significant stake
of, say,
more than 5% in any smaller company as this gives it real
incentive to drive the share price forward. On the other hand,
too great a stake and there’s a danger the firm may be run as a
comfortable “family” firm, not one with an ethos of
maximising earnings growth. There’s often also the potential
that the directors listed the company to maximise their
personal wealth (push the share price up), before selling the
company to the highest bidder.
• It’s equally disheartening to see senior managers whose pay
levels and annual remuneration increases bear little
relationship to the company’s record of adding value for
shareholders. Always check a company’s senior managers are
demonstrating real financial commitment to the company,
rather than to themselves, by taking home pay commensurate
to the size of the business and pay rises commensurate with its
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How To Make Big Money In The Exciting World Of Penny Shares
success. Notes in the annual reports about “material
transactions” with other companies in
which a director has an interest are often signs that managers
are topping up their salaries via the back door. If this is the
case, we’d rather invest elsewhere.
• Finally, it’s always worth noting recent share purchases or
selling by directors. If the top men are lightening their equity
holdings, that can’t be seen as a vote of confidence and,
perhaps, you should follow suit. The reverse is also true. There
are several websites that provide free access to main
shareholder structures, one of the best is www.fin24.co.za.
• As important as the management’s financial interest in
maximising shareholder value, is its ability to deliver that
value. It seems heartless, but you should rarely give a failed
chief executive a second chance – it pays to back proven
winners, rather than those who’ve failed before.
• Ask yourself: Whatever the odds, should you risk your wealth,
your portfolio of shares to someone who’s already failed?
2. Never back those who break their promises
• Just as perennial losers should be shunned, so too should those
vehicles that persistently fail to meet expectations. The stock
market won’t tolerate “promises of profits tomorrow” forever,
and a record of issuing profit warnings will inevitably see the
shares de-rated, unlikely to be re-rated even if the profit
warnings cease. The market adage is profit warnings usually
come in threes. Sadly, it’s often in fours or fives.
• The bottom line is well-managed firms in growth industries
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How To Make Big Money In The Exciting World Of Penny Shares
don’t issue regular profit warnings, either overtly through the
stock exchange or covertly by telling brokers to cut their
forecasts.
3. Listen to what a company’s rivals are saying
• Before investing in a particular company, it’s sometimes a
good idea to check what rivals are saying about its current
prospects. If the company you’re thinking of backing seems to
be singing from a completely different hymn sheet than its
competitors, it shouldn’t pass the filter test.
Experience and commonsense tell you that if something
sounds too good to be true, it probably is.
4. Let the trend be your friend
• It’s usually better to invest in shares that are on an upward
trend than ones that are on the reverse, a sensible investor
should let the trend be his friend. A share may look cheap,
but if its price is on a persistent downward path, it often
means someone, somewhere, knows something bad. If you
were aware of similar information, chances are you wouldn’t
think the share was still cheap.
• If you still think a particular share looks cheap after it’s started
to fall, wait until it stops falling and has, instead, risen for a
couple of days before buying. If you buy falling shares in the
hope that “surely they can’t go any lower” or if you buy shares
that fail the normal Red Hot Penny Shares’ filters just because
they “look cheap”, you’ll quite possibly get badly burnt. This is
the stock market equivalent of the old adage: “Never catch a
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How To Make Big Money In The Exciting World Of Penny Shares
falling knife.” In the investment world, this is very useful to
remember.
• You should also not chase a price up. If Red Hot Penny Shares
selects a share at 200c, it’s because we believe you can
reasonably expect to make a 50% return on your purchase
within 12 months and, possibly, considerably more.
However, traders have large research departments, with
analysts who monitor all share recommendations (especially
those made by someone with a record of success) very carefully.
They’ll respond to these tips by aggressively buying these shares
and pushing the price up. So if, by the time you come to buy, the
shares are already trading at 250c, any subsequent purchase will
already have missed most, if not all, of the upside. But if you and
other sensible investors hold off from buying immediately, the
share price will often retrace slightly and offer a better buying
opportunity. So, it often pays to be patient and wait a few days or
weeks before you make your purchase.
5. Avoid companies that change advisors or
directors frequently
• To lose one non-executive director or one key advisor is
acceptable. To lose two is careless. But, to lose more is
terrifying.
• An unexplained resignation by a non-executive director, or
change of sponsoring stockbroker or merchant bank, is always
worth investigating. When these supposedly impartial
directors or advisors, whose role is to protect shareholders’
interests, quit without explanation, we start to become
concerned.
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• Unless both the company and the departing non-exec or
advisor can give a cogent and plausible reason for the parting
of ways, the company doesn’t merit your financial support.
• When there’s a series of boardroom resignations or a repeated
changing of advisors or brokers you should become extremely
concerned. At best, it may suggest the company’s senior
management find it hard to maintain decent business
relationships. At worst, it suggests rather more serious
problems.
Either way, the company involved isn’t one in which you
should invest.
6. Listen closely – what is said is often not what
is meant
• Reading between the lines isn’t always easy, but sometimes it
pays to take notice of hints that all may not be well. This
involves being a psychologist to some degree, but often the
small nagging voice deep down inside indicates danger.
7. The mission statement
• A mission statement is necessary for a company to give focus
to its strategy. Essentially, a statement enables business to
bring people together with a focused, common ideology and
direction. In addition, the company can make sure the whole
strategic planning process is integrated throughout the entire
group.
• However, if the mission statement is too broad, it results in
“blue sky” type planning, which should be restricted to
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How To Make Big Money In The Exciting World Of Penny Shares
boardroom brainstorming sessions. A statement that’s too
narrow results in channel vision and foregone opportunities.
This implies a brief look at a company’s statement should give
the investor an understanding of the general direction the
firm should be taking. If not, why you should you invest in a
company that can’t even keep to its own agenda?
8. Market and industry characteristics
• Another non-mathematical method of determining whether a
company has a suitable strategy is an investigation of the
opportunities and threats it faces with regard to the
environmental factors within which it operates; including,
politics, economics, finance, global threats and opportunities,
technology, social change and labour issues.
• The dilemma strategists face is what factors to include and
exclude when setting up key criteria for decision-making. One
approach is to identify key characteristics of the environment
arising out of product life cycle and other major factors that
affect business. Some key filters include characteristics of the
market, competitors, market fragmentation, entrepreneurial
flare of management and possible synergies arising out of a
takeover, acquisition, merger, etc. Stated differently, a
company, market or share is considered attractive if its
potential for providing a significant contribution to objectives
(mission statement) can be met (i.e. earnings growth, cash
flow, return on investment or assets, dividend income or
capital growth).
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Conclusion
• So, even before analysing the financial statements of a
company by referring to its last published annual report and
any formal stock exchange announcements made in the past
couple of years, someone using the
Red Hot Penny Shares’ filter system should be able to eliminate
at least half, if not more, of the 400 smaller company shares
on offer as unsuitable for his or her portfolio.
• Remember: Unless a company’s managers have a record of
success, and show financial commitment and confidence in
the business; unless those managers have a record of meeting
expectations, and there’s a record of boardroom continuity
and of stable relationships with their advisors; unless the
company makes promises that appear realistic in relation to
those of its rivals; and unless the share price is, at worst,
stable, then the company has failed the Red Hot Penny Shares’
non-financial filters.
As such, it doesn’t merit a place in your investment portfolio.
Part II: The financials
The non-financial filters will probably have weeded out at
least 50% of
the companies that financial and other contacts suggest we
investigate every week, and so it’s only at this stage that the
company’s annual report truly comes into its own. You can use
these statements to gauge the financial health and prospects of
the business. As before, there are a number of filters that should
be enough to eliminate all but a few potential candidates for
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investment.
It might be surprising, but it’s always worth starting corporate
detective work at the back, rather than the front, of a company’s
annual report. At the beginning, there should be a statement
from both the chairman and CEO outlining the events of the
past year and putting as positive a spin as possible on the
company’s prospects. Reading between the lines of this statement
can unearth a few concerns, but the first third of an annual report
normally contains nothing more than a restatement of a handful
of corporate clichés and a collection of glossy photos of fat-cat
executives. In other words, the content is unlikely to be either
particularly useful or especially aesthetically pleasing.
In the middle of an annual report are the income statement,
balance sheet and cash flow statement. More about these later.
However, it’s the final section, the notes to the accounts,
that’s often most illuminating since it contains details of the
accounting policies used in the preparation of the annual report;
details of litigation the company might face in future; directors’
remuneration; share option packages and other such nuggets. In
other words, the notes to the accounts are crucial.
1. Don’t be obsessed by litigation, but don’t
ignore it either
• Nearly all companies, especially those doing business in
litigation-obsessed places such as the USA, will find
themselves involved in a legal case sooner or later. So, just
because the company admits it’s being sued in its report and
accounts isn’t necessarily a reason not to invest in it.
However, smaller companies can be seriously damaged by just
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one large and costly legal case, so be careful.
• Normally, the directors will give their view on any
outstanding litigation claiming, hopefully, that it isn’t
“significant” in the context of their overall business or is, in
their opinion, “unlikely to succeed”. Since the successful
penny share investor is, like Warren Buffett, prudent, unless
both of the above caveats are contained with reference to
outstanding legal matters, it’s probably safer to walk away.
• Equally, if you subsequently discover a company has
“neglected” to mention its potential legal liabilities in a public
document, it raises such serious concerns about the
trustworthiness of its directors you should always walk away.
2. Are the company’s accounting policies both
reasonable and normal?
• In the notes section of an annual report, the company must
explain how it treats accounting issues, such as depreciation of
assets, capitalisation of interest payments, and research and
development spending. Such matters are crucial as these affect
headline profits. You’ll also find a schedule of values for its
underlying assets in the notes section – more about these
values later.
• Depreciation refers to the amount set against stated profits to
cover the reduction in value of fixed assets over time,
effectively wear-and-tear. Capitalisation of interest refers to
the accounting practice where certain interest costs aren’t
written off against profits, but are added to the balance sheet
as an asset and depreciated in subsequent years.
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• The effect on stated profits can be significant. For instance, if
a company writes down the value of a piece of machinery over
20 years, whereas its rivals write it off over ten years, the first
company would (because it had a lower annual depreciation
charge over the first decade) report higher profits than its
competitor.
• Similarly, by capitalising an unusually high amount of interest
costs in a particular year, a company can flatter its profits
artificially even if, in subsequent years, its profits will be
reduced because it has a greater asset base to depreciate.
• Some companies also choose to capitalise research spending
rather than writing it off against profits. They claim this is
because such spending will have the long-term effect of
growing their business. But the most obvious effect of such a
policy is to flatter both the income statement (by “reducing”
costs) and the balance sheet (by “increasing” net, albeit
intangible, assets).
• Capitalisation of interest, for instance, isn’t per se a necessary
cause for concern. For instance, when building a nursing
home, the interest bill prior to opening is a cost, just like
labour or bricks, necessary to create the completed final asset.
Since the value of that asset is effectively its replacement cost,
capitalising interest is probably not unfair.
• However, it may become a concern if the policy adopted is
noticeably different from that of the company’s competitors.
Certain nursing home operators, for instance, used to
capitalise interest costs until the homes they had built were
three quarters full. The mere fact those operators were
adopting policies that flattered their profits, while their peers
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refused to adopt these policies, should have been a cause for
concern for potential investors.
• Occasionally it isn’t even necessary to check out the policies
adopted by rivals. Gut instinct will do! If, for instance, a
company says it depreciates its car fleet over more than five
years it’s blindingly obvious that, since those cars will need to
be replaced before the half-decade is out, the sole purpose of
adopting such an unrealistic policy is to flatter profits and
earnings per share.
• The point about aggressive accounting policies is while they
may flatter earnings for a certain time, they do nothing to
change the underlying trading position of the company
concerned. When an economy’s on the verge of entering a
recession, or at least an economic slowdown, it becomes more
difficult for the aggressive accounting firms to paper over the
cracks and the chickens will inevitably start coming home to
roost.
3. Is the company really growing and adding
value for share holders?
• Moving from the back of the accounts to the middle, one
should start with the income statement, which should show
the company’s turnover (revenue in the case of finance
houses, banks and private equity firms), operating profit before
interest and tax, interest paid or received, tax paid, net taxed
profits, extraordinary costs, attributable profit and dividends.
These figures are stated for both the current year and the
previous year. In the case of a holding company (i.e. a
company with subsidiaries), there will be a second set of
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figures, one for “company” and one for “group”. The group
figures are used to assess the whole organisation, while the
figures for “company” will show you whether the holding
company is a trading one, or simply a means to maintain a
strategic overview of the whole organisation.
Remember to use one set of figures constantly, or you could
end up double counting profits or debt and get a distorted picture
of the group’s financial performance.
• The income statement isn’t a snapshot picture of the
company’s position at the year-end, but a record of its
achievements over the previous trading period.
• The key test for Red Hot Penny Shares and other potential
investors is whether the company appears to be growing in a
sustainable manner and in a way that creates extra value for
its shareholders. We’d hope to see it had achieved steady
turnover growth without having to sacrifice its operating
margins – in other words the company wasn’t cutting prices
merely to shift stock. The operating margin is calculated by
dividing turnover (as a percentage) by operating profit before
interest and tax.
• More importantly, Red Hot Penny Shares will normally only
research shares of those companies with a consistent record for
generating steady growth in earnings per share (EPS).
Earnings per share is the net profit of a company after paying
all costs, including interest and tax, divided by the number of
shares in issue, and is a far more useful indicator of growth
than pre-tax profits. In South Africa, accounting firms have
added what is today referred to as headline earnings per share
(HEPS), and is the attributable profits before extraordinary
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costs divided by the number of shares in issue. The reason for
this calculation is, if a company sells an asset (an
extraordinary profit), it could positively distort EPS for that
year. HEPS excludes that profit. Of course, if the
extraordinary item was a loss, the opposite would be true.
HEPS is the sustainable growth in a company’s earnings,
excluding extraordinary profits or losses.
• In addition, many companies can grow headline profits by
issuing new shares in order to acquire assets or indeed other
companies, but add nothing for shareholders in doing so. For
instance, if Company A acquires Company B by issuing fresh
equity in a deal that increases its number of shares in issue by
10% and the deal increases pre-tax profits by only 5%, the
transaction will look good at the pre-tax level but won’t
enhance EPS. It will, in fact, have a dilution effect on
earnings.
• Unless a company has a consistent record of growing sales
without compromising margins and of adding to HEPS, it fails
this particular
Red Hot Penny Shares’ filter.
4. Cash is king
• Newspaper share tipsters and professional investment analysts
seem to be extremely obsessed by a company’s HEPS growth.
While important, it should never be-the-be-all and end all of
industrial analysis, because no business can survive without
cash.
• You should, therefore, always be extremely nervous if a
company’s failing to generate cash at an operational level,
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How To Make Big Money In The Exciting World Of Penny Shares
something that’ll be apparent if you read the cash flow
statement in its annual report. In the long run, companies
must generate cash from trading, because they can’t survive
forever by running down stock levels or squeezing debtors
while pushing creditors for more generous terms. A well-run
business in a growth market can live with high borrowings if
it’s had to invest heavily, but if it’s failing to generate cash,
you should be extremely nervous.
• As a general rule, if cash flow generated from operations falls
well below operating profits, then Red Hot Penny Shares would
rather stay well clear.
5. Don’t ignore the balance sheet either
• The final part of the mid-section of a company report is the
balance sheet, a statement of what the company owns (its
assets) and owes (its liabilities) at the period end. As such, the
balance sheet can be slightly misleading. For instance, at the
end of December, a typical retailer should have lower
borrowings and more cash than at the end of November,
because it’s just completed its busiest trading period of the
year. In the period before the Christmas season, most retailers
would have high borrowings to support high stock levels, but
little cash. Not surprisingly, most retailers have an endDecember year-end in order to make their balance sheets look
as healthy as possible in the annual report.
• Having said that, balance sheets can be misleading because of
timing and strange accounting policies that relate to items
such as capitalisation of research spending. Analysts use the
balance sheet as an indication of the financial strength of a
company.
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How To Make Big Money In The Exciting World Of Penny Shares
• The most commonly quoted balance sheet ratio is gearing,
which is a company’s total debt (long- and short-term loans
and bank overdrafts, but less cash) expressed as a percentage
of its net assets. If a company’s gearing is high (say heading
towards three figures) you might wonder whether it has the
organic resources to invest in a new plant for expansion,
whether it can afford to increase its dividend or, indeed,
whether it has any prospects of ever repaying its debts.
• This is perhaps a little simplistic. Some companies (such as
the pharmaceutical giants) actually have very few tangible
assets and so can look highly geared. But since they’re highly
cash generative and their interest payments are normally
covered by profits many times before interest and tax (PBIT),
they have real scope to invest, repay debt and still reward
shareholders. In addition, a company’s annual report is usually
released three months after its year end and, so, any ratio
could be significantly outdated.
Use the balance sheet as a barometer and feel free to phone
the company secretary and quiz him or her on the ratios.
• When an economy is expected to slow down and interest rates
are expected to rise, it pays to be cautious when assessing an
investment opportunity, particularly if a company’s gearing
looks high in both absolute terms and relative to that of its
competitors. It’s unlikely to be a prudent investment for
someone keen to follow Warren Buffett’s first rule.
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How To Make Big Money In The Exciting World Of Penny Shares
2
Valuation: The Final Filter
Red Hot Penny Shares’ first rule of investment is a bad share that
fails to pass the investment criteria is never a buy, whatever its
share price.
Red Hot Penny Shares’ filter system should by now have
weeded out those shares that’ll never outperform the market by
enough to make them a satisfactory home for your money.
Probably around 75% of South Africa’s penny shares will fail
to pass the filter system, and merely by avoiding those laggards,
the portfolio of a good fund manager will outperform the universe
as a whole.
But, the key to making big gains is by buying quality shares
when their valuation is right.
It can’t be said often enough: There really is no such thing as
a “trading buy”, although that’s something few brokers seem to
understand. Sure, you may get lucky trading in and out of
fundamentally dud shares, making a quick turn here and there for
a while. But dud shares with poor managers or negative cash flow
will inevitably come up with a shock profit warning,
unexpectedly large losses or unforeseen management upheaval.
When that happens, the enormous losses taken by the shortterm trader or speculator with a position in the share will more
than offset the small trading gains he’ll have made elsewhere.
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How To Make Big Money In The Exciting World Of Penny Shares
Instead, Red Hot Penny Shares seeks to focus on buying into
quality growth stocks when the timing and the price is right.
That doesn’t mean we expect to see massive gains overnight or
even next week. It may take months or even over a year before
the market realises a company’s full potential. When that
happens, the excitement and the profits for those who become
involved when we select a share will make it well worth the wait.
Although Red Hot Penny Shares highlights only those shares that
we expect to see make significant gains in three to 12 months, a
successful investor must be prepared to be patient.
Back to valuation
• Over time, there have been well-known investment gurus,
here in South Africa, in the UK and in the US. Perhaps the
best-known investor in Britain is Jim Slater, for whom it’s
hard not to have the greatest of respect. Slater’s proven
methodology is based on the principle that a share looks
cheap if the prospective price earnings growth ratio (that is to
say the PE ratio divided by the annual EPS growth rate (e.g.
50%) is less than a certain multiple). See definitions of PE
and EPS in your Buying and Selling Shares booklet.
• The trouble with such a rigid filter is it can leave one with an
exceptionally narrow universe of potential shares, unless the
multiple (known as the price earnings growth or PEG
Multiple*) is exceedingly generous. In the early 1990s, you
could find plenty of good growth shares trading on PEGs of
around one.
*
24
The number used for annual growth rate can vary. For example, it can be
forward (predicted growth) or trailing and either a one to five year time-span.
Check with the source providing the PEG ratio to see what number they use.
How To Make Big Money In The Exciting World Of Penny Shares
• That isn’t to say the PEG theory isn’t valid, but only if used
loosely to eliminate those shares that appear to be grossly
overvalued.
• Those quality shares that appear to be sitting on generous
PEG multiples of well over 1.5 are worth monitoring, because
– should their share prices retreat over time or they’re dragged
down with the rubbish during an overall market correction –
they could well come back into buying range.
• However, that’s for the long-term. In the more immediate
term, it’s our job at Red Hot Penny Shares to identify those
shares that have passed more rigorous filter checks, which
offer the potential for delivering significant and sustainable
long-term earnings growth, and whose value isn’t yet
discounted in its share price.
• By using the proven filter methodology and buying only on
sensible valuations, there’s no reason the winning streak
should come to an end.
Assessing the true value of a company
• As stated earlier, another form of valuation can be conducted
by assessing the true value of a group. At the back of the
annual report, you’ll find a schedule of subsidiary and associate
company valuations. These can be used to re-value a company
and to assess value relative to share price. If the share is
trading at less than the re-calculated value, the market has
valued the company at a discount to its underlying assets and,
if higher, at a premium to underlying assets.
• Once the assessment has been completed, the question is to
assess the reasons for such a discount or premium. Usually, the
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How To Make Big Money In The Exciting World Of Penny Shares
assets are undervalued because such valuation was done years
ago. Another problem is that a balance sheet is a snapshot in
time, but values change constantly.
• Here’s how you go about re-valuing a company.
Step 1: Re-value the group’s listed assets. Take a holding
company’s percentage stake in its underlying companies and
calculate the value of its investment at the current share
price. Repeat this for all its listed divisions and add these to
get a total value.
Step 2: Re-value the group’s unlisted assets. The value of
subsidiaries and associates will either be at book value or
directors’ market value. A list of the holding company’s
percentage holding in those companies is also stated here.
Now, look at the values and consider if these are realistic –
were they valued recently or years ago? If you believe these are
realistic, use the figures. If not, take the attributable profit of
these underlying assets and multiply that number by the sector
price earnings (if a media company, use the Media Index and
so on). This will give you a realistic value for this entity.
Repeat the exercise for all underlying assets and total these up.
Step 3: Re-value the group’s net cash to debt. Take the last
annual report (final or interim) and work out net cash to debt.
Step 4: Work out the total shares in issue. Add up all the shares,
including ordinary shares, N shares, preference shares and
debentures.
Step 5: Calculation of true net worth of a company. Add the
values in step 1, 2 and 3 and divide this by the value in Step 4.
The figure is the re-calculated value of the company per share.
If this is higher than the share price, the share’s trading at a
discount, if lower – the share is at a premium.
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How To Make Big Money In The Exciting World Of Penny Shares
The following is a fictitious example: Recalculation of International Finance Ltd [IF]
A
Net Wor th Calculation
B
Shar e Pr ice (live)
C
Pr emium/(Discount)
[ (1+2+3) ÷ 4 ]
[ (B ÷ A) ex pr essed as % ]
(R)
56.17
(R)
32.00
(%)
(43.03)
1. International Finance Ltd’s Listed Investments
IF’s Listed
Divisions
Listed Entities’
Issued Share Capital
million
Held by International
Finance Ltd
%
million
Net Worth
Value of Entity
R/Shar e
Share Price of Actual
% of
Listed Entity
Value
Total
Rands
R’million
%
Banco de Br azil
500
75.00
375
12.00
4,500
45.8
25.7
Colombia White
200
10.00
20
5.00
100
1.0
0.6
Total Listed
–
–
–
–
4,600
46.8
26.3
2. International Finance Ltd’s Unlisted Investments
IF’s Unlisted % Held by International Division’s Total Division’s Attributable Estimated Price:
Finance Limited
Investments
Earnings (Rm)
Earnings (Rm)
Earnings (times)
Estimated
Value (R’m)
% of
Total
Net Worth
Value of Entity
16.0
Pr inter s Co.
100
200
140
20
2,800
28.5
Fr eeTown News
50
120
84
35
2,940
29.9
16.8
5,740
58.4
32.8
Total Unlisted
3. International Finance Ltd’s Other Investments, Net cash to debt position
Estimated
Value (R’m)
% of
Total
Net Worth Value of
Entity (R/share)
Pr inter s Co.
-110
-1.4
Fr eeTown News
-400
-4.1
-0.78
-2.3
Total Unlisted
-510
-5.2
-2.9
4. International Finance Ltd Share Capital
1. Or dinar y Shar es in Issue
100,000,000
2. Pr efer ence Shar es
50,000,000
3. N-Shar es
25,000,000
T OTAL SHARES IN ISSUE
175,000,000
Value of International Finance Ltd
T OTAL (1+2+3)
R9,830 million
Per Shar e [(1+2+3) ÷4]
R56.17
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How To Make Big Money In The Exciting World Of Penny Shares
Explanation of example
• Inter national Finance Ltd has a cur r ent shar e pr ice of R32.00, but a r e-calculated net wor th
of R56.17, which means the company’s shar e is tr ading at a 43.03% discount to its tr ue
wor th.
•
In calculating its tr ue wor th, cur r ent updated mar ket values for its listed entities wer e used,
while a r ealistic pr ice ear nings r atio for unlisted divisions was assessed and used to calculate net wor th.
•
T he net wor th was thus as follows:
•
1. Listed Investments
R4,600 million
2. Unlisted Investments
R5,740 million
3. Other Investments, Net Cash to Debt Position
(R510 million)
T OTAL VALUE (Addition of 1,2 and 3)
R9,830 million
1. Total Value
R9,830 million
2. Total Issued Shar e Capital
175 million
3. Total Value Per Shar e (1÷2)
R56.17
Pr emium Discount r ating (R56.17 ÷ Shar e Pr ice of R32)
43.03%
T he model also identified that the unlisted entities r epr esent R32.80 of the net wor th of Inter national Finance Ltd. T his is slightly mor e than the value of Inter national Finance Ltd’s
shar e pr ice.
“When we put a company through its paces we’re like ruthless
military PTIs”
In addition, we’ve set up a ratio analysis system to
complement our fundamental analysis of the shares we’re
investigating. This is set out as follows:
• It starts with a broad brush-stroke to see if the company is
insolvent. If not, we move on to the next step.
• If ratio analysis reveals the company is, indeed, solvent, then
is it liquid? The question assumes that, if it doesn’t have a
reasonable liquidity, Red Hot Penny Shares subscribers run the
risk of buying shares in a company that might, in future, be
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How To Make Big Money In The Exciting World Of Penny Shares
placed under provisional liquidation.
• A company that’s both solvent and liquid may not be
profitable. Depending on the level of profitability, Red Hot
Penny Shares subscribers may not be interested in buying
shares and could move on to assessing other company profiles.
• Assuming a company is sufficiently profitable to warrant
further investigation, the path takes a look at efficiency and
leverage levels. The assumption is based on a premise that a
profitable company won’t be profitable for long if it’s
inefficient and has a high debt to equity ratio.
• A company that’s efficient and moderately geared must also
reflect positive market sentiment.
If the company fulfills all the fundamental and ratio analysis
prerequisites within the global and regional economic and
political environments, we’ll tell you about the share.
Ratio analysis
Insolvency: (Fixed assets + investments + current assets) x 100
(Long-term loans + current liabilities)
Liquidity: Quick ratio (acid test)
Profitability: Return on
shareholders’ equity
Efficiency: Accounts
receivable days
= (Current assets - stock)
Current liabilities
= Attributable profits
Shareholders’ funds
x 100
= Accounts receivable
(Turnover ÷ 365)
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How To Make Big Money In The Exciting World Of Penny Shares
Leverage: Gearing
= (Long- and short-term loans
+ overdraft - cash)
x 100
Ordinary shareholders’ funds
Investment performance: EPS = Attributable profit
Issued ordinary shares
30
x 100
How To Make Big Money In The Exciting World Of Penny Shares
3
Special Situations
“T
oo many investors look for special situations – trying to
identify the next ‘big thing’ – often resulting in a specific
industry becoming popular. That popularity will always be temporary
and, when lost, investors won’t return for many years.” – Templeton
(Value Investing).
Both Jim Slater and Warren Buffett are notoriously wary of
what might be termed “special situations” – those shares that fail
all conventional valuation methods, especially rigid systems such
as the PEG theorem. Generally
Red Hot Penny Shares would be inclined to agree that sectors, like
biotechnology, e-commerce and software development, are
unnecessarily risky. Why risk your hard-earned cash on what
could ultimately be a gamble, when you can be fairly sure of
making excellent returns from relatively low risk – and certainly
low downside – investments elsewhere?
It’s a valid question. The answer is to invest only when you feel
you’re in possession of specific information that gives your
investment strategy an edge over the wider market. At Red Hot
Penny Shares, we have excellent connections in the mining and
construction worlds and in oil exploration, another sector where
conventional investment criteria such as PE ratios or operating
margins mean absolutely nothing. Of course, such investments
will always be subject to unusual risks. As such, selections will
always be flagged as being only for speculative investors, for those
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How To Make Big Money In The Exciting World Of Penny Shares
seeking some real excitement, thrills with the risk of spills, for a
small portion of their portfolio.
Perhaps the most obvious example of a special situation is the
shell, a company best defined as a trivial business – or, more often
than not, a previously viable business that’s collapsed – which is
then taken over and transformed into something more
significant.
Essentially, a shell’s only assets are likely to be its stock market
quotation, its shareholder list, possibly some inherited tax losses
and the intangible value of a new, dynamic management team
that’s been brought in to create shareholder value. By far the
greatest gains come from investing in a shell during its early
stages, before it becomes “just another company” and as the wider
market slowly comes to realise the transformation that’s taking
place.
There are, of course, various approaches to investing in shells.
One could merely trawl through various directives identifying
suitable target companies and wait patiently for something to
happen. Perhaps a company “doctor” would be inserted by
shareholders to find some deals to help create a new company.
Alternatively, a private company may wish to use the shell as
a vehicle to achieve a stock market quotation. This would be
engineered by a reverse takeover, the shell buying the private
business in a reverse takeover. Either way, it could prove a long
wait before the randomly chosen shell starts to deliver some value
and excitement for you, the speculative investor.
Red Hot Penny Shares would rather use our extensive market
and industry contacts to warn you of situations where a new
management team with a proven track record’s already in place.
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How To Make Big Money In The Exciting World Of Penny Shares
Although that might have caused some uplift in the share price,
it’s more than probable that the real gains will be made when the
new directors start to do their first few deals. So, there will still
be big profits to be made and, hopefully, you won’t have to wait
too long to see them.
Recovery shares: This term relates to companies that were
once high flyers and, for various reasons, have fallen from grace.
Various internal disasters are normally the reason for the share
price wipe out. BUT, don’t write off all of these companies, as
many of them can offer huge rewards for the astute investor.
Once the “fix it” guys have had a run through the company and
put things right, wise investors get a whiff of better things to
come and buy in, normally well ahead of the actual fundamental
turn around in the company. These can be risky adventures but
also highly rewarding. You need to make sure that the actual
events that caused the fall out have been addressed. A very good
way of seeing that this is the case is in the share price graph.
You’ll see the big fall on the left hand side, then a “saucer”
bottoming out formation and finally the new upward move.
With recovery shares, the other thing I look for is sales.
Buying shares on a low price to sales ratio has been a successful
investment approach. The reason, sales are customers and
customers are business. It’s much easier to do something about
your costs than it is to drum up new sales. You can fire half your
workforce today and restore your profit margin, but if no-one
wants to buy your product, then there isn’t much you can do
about it.
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How To Make Big Money In The Exciting World Of Penny Shares
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How To Make Big Money In The Exciting World Of Penny Shares
4
Stop Losses, Profit Taking
and Top Slicing
I
n the current volatile market in which we find ourselves, it’s
not unusual for investors to wake up to find that the value of a
whole swathe of their shares has fallen dramatically in just one
trading session. One solution to that problem is to apply a “stop
loss” to all or some of your portfolio. That’s to say, you set a
predetermined selling point that’s triggered if the share price falls
through it and, thus, acts as a mechanical aid to selling decisions.
It’s a strategy advocated very convincingly by Michael Walters,
one of the few financial journalists writing today to command
respect in the investment world.
Stop losses are variable and are set as a percentage of the
current share price. With a share trading at 100c, for example, a
typical 25% stop loss would be set at 75c (100c minus 25% of
100). As the price rises, so too does the stop loss. So, should the
shares hit 120c then the stop loss would increase to 90c (120c
minus 25% of 120c).
Although stop losses can rise, they never fall in any
circumstances. So, in this case, if the shares fall to 92c, the stop
loss remains at 90c. If they then subsequently fall by another 2c
you sell immediately.
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How To Make Big Money In The Exciting World Of Penny Shares
The point of setting stop losses
• Firstly, you never bail out while shares still have upward
momentum (remember, let the trend be your friend) since
selling decisions are triggered only by a downturn in the longterm growth pattern, not by your personal, and irrational,
concerns.
• More importantly, a stop loss system stops you from holding
onto investments in situations where it’s rapidly becoming
apparent that you have, for whatever reason, made a mistake
or where unforeseen circumstances have moved against you.
We all find it hard, whether as investors ourselves or as share
tipsters, to admit we’ve goofed. But, if we do, it’s usually
prudent to cut our position and minimise the loss before the
situation deteriorates further. Applying a stop loss forces us to
do this.
• The problem is to decide where stop losses should be set. At
25%, the trigger is relatively sensitive and could mean –
especially in today’s volatile markets – you cut positions
erroneously. Your trading volumes will be relatively high
(which will make your commission-hungry broker very happy)
and you’ll let some real long-term winners escape your
clutches. On the other hand, you’ll always avoid the real
horror stories.
• Alternatively, some stop loss practitioners would advocate
setting a tripwire at a relatively insensitive level such as 50%.
This will – we hope – rarely be triggered and, if so, only to
ensure you avoid real catastrophes. However, unless you also
take a relatively pro-active attitude to weeding out other
perennial laggards (but not outright disasters) within your
portfolio you could find yourself lumbered with some
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How To Make Big Money In The Exciting World Of Penny Shares
perennial underperformers. The 50% tripwire will, in effect,
not absolve you from the tough decision of when to sell the
underperforming investment.
• The level at which you set a stop loss position is very much
down to your own attitude to risk. If you’re innately cautious
you might tend towards 10%, the more speculative among you
might head towards 50%. Red Hot Penny Shares constantly
reviews all our recommendations and will update our
investment stance in the light of any share price weakness.
But while every investor shouldn’t only set their own stop loss
rules, and stick rigidly to them, it isn’t for us to dictate to you
what should be your attitude to risk. Red Hot Penny Shares
publishes a 25% trailing stop loss on the tipped price of the
shares.
• Whether to take profits, or not, is the subject of almost as
much debate among investors as the right level for setting stop
losses, although it’s a rather more enjoyable dilemma to face.
• One theory is one should always sell the losers within your
portfolio and hold onto the winners for the long-term. There
is some statistical backing for this strategy. The US
investment guru James O’Shaughnessy has shown over a 40year period those shares that lagged their peers at the
beginning continued – on average – to perform poorly relative
to the stars in any other given timeframe of several years.
• But, on the other hand, in the long-term we’re all dead. At a
certain stage, you may wish to realise some gains. Perhaps,
more importantly, the sensible investor realises that overall
market sentiment can be fickle and volatile, and underlying
economic and political conditions can change.
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How To Make Big Money In The Exciting World Of Penny Shares
• When reviewing the state of your portfolio it’s always worth
asking: Would you invest in this particular share now, even
after it has soared in value, at its new higher price? If the
answer is an unequivocal “no”, then perhaps your cash would
be better deployed elsewhere.
• While a sensible stop loss strategy means you avoid excessive
exposure to the stock market’s losers, it would be wrong to sell
your entire holding of proven winners merely because the
short-term share price looked a touch overheated. The
exception, of course, would be if you were convinced a
cataclysmic change in sectoral or market conditions was
imminent. Even so, could you be confident you’d called the
timing of such a downturn completely accurately and weren’t
missing out on a little bit more outperformance?
• Now seeing as we’ve used examples of the Warren Buffett
approach, I’d like to add that he’s never used a stop loss in his
life! He’s a long-term investor and is happy to ride out market
downturns. So, if you’re a long-term investor and you know
what you’re doing, it’s quite appropriate to use a much wider
stop loss or none at all. I think the main point when it comes
to the stop loss is you’re comfortable with your choice and it
relates to your time frame for the investment.
Top slicing
• Red Hot Penny Shares advocates a sensible strategy of top
slicing. The golden rule is to sell half your holding on a
double. If a particular share doubles in value and you sell half
your holding, you’ll cover all of your initial cash outlay and
will be guaranteed not to lose any money. If the share price
doubles again, then consider selling another half.
38
How To Make Big Money In The Exciting World Of Penny Shares
• That way, you’ll have made a guaranteed gain of 100%.
Thereafter, you can just leave your shares to soar and not
worry what happens next, because you’ve already banked a
massive gain.
• The more cautious investor might not wish to wait for a
double and may wish to top slice when sitting on a gain of
only 66%. Should such a strategy suit your individual riskprofile no-one can argue with you. You can’t lose money on
realised gains.
• The hopes of gaining capital growth in dollars or pounds is
bound to attract many investors and, here, I recommend a
rigid policy of both top slicing and stop losses. It’s difficult
enough to invest in a familiar market, but in the globalised
world, the risks mount up quicker than the potential profits.
• Intermittently, Red Hot Penny Shares will suggest selling out
altogether, because we hear rumours of an impending change.
Sometimes that may appear premature, but it would be
prudent to warn you.
Summary
• Your attitude to stop loss strategies, profit taking and top
slicing will depend very much on your own attitude to risk
and, occasionally, on your need for cash and your own
personal gearing.
• Red Hot Penny Shares will suggest, whenever appropriate, on
cutting losses or, more usually, on banking some of your gains.
You may, however, wish to pursue a more aggressive or
cautious strategy than the one we outline. That’s your choice,
39
How To Make Big Money In The Exciting World Of Penny Shares
but it would be foolish to ignore the potential offered by stop
loss and top slicing theories when managing your portfolio.
• The market has a life of its own, totally independent of the
individual companies listed on it. This means you must know
what moves the market to make a success of your investing
activities.
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How To Make Big Money In The Exciting World Of Penny Shares
5
Conclusion
Contrary to what some pundits may have you believe, investing
sensibly doesn’t mean backing just dull multinationals like Sasol
or Liberty Life.
After all, some have issued quite ghastly profit warnings in the
past that saw their share prices virtually collapse. If you really
want security, and are happy with minimal returns, leave your
cash in a bank deposit account and hope for a conversion
windfall.
We, at Red Hot Penny Shares, believe our members are looking
for a little more excitement and much greater returns than those
offered by these conglomerates.
That doesn’t mean investing in smaller company shares is like
gambling. A sensible spread of investments that have passed Red
Hot Penny Shares’ rigorous share selection procedure should
deliver significant returns.
We admit there’ll be occasional flops, because no matter how
perfect any system or share may seem, it’s always vulnerable to
unexpected developments. We can’t pretend all the shares we
research will be big winners and there won’t be the occasional
upset.
However, we can spot companies with strong management,
sound products, healthy finances that appear to be well
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How To Make Big Money In The Exciting World Of Penny Shares
positioned for growth. If you buy a decent selection of shares, you
may not strike gold at once, but you can realistically expect to
increase the value of your portfolio over time. That’s something
Red Hot Penny Shares is here to help you achieve.
The vital secret of knowing when to sell:
When the objectives for which you bought the share have been
met – sell.
• When a share hasn’t performed according to expectation and
you’ve given it time to do so – dump it. There can be a
multitude of reasons for this – just move on.
• Things go wrong within the company or the big picture
environment for that matter and it looks like the company’s
swimming with an anchor around its neck – dump it.
• Shares get overvalued. If this is the case, a new downward
trend is in store and, depending on your time horizon, you
might want to sell or lighten up.
• Learn to listen to that small voice deep down within. Don’t
let your emotions get in the way – follow your instincts.
One last piece of advice
• Never change your long-term strategy based solely on shortterm market performances. Many traders have such an ego
attached to their trading skills, they can’t handle losses.
Several losses in a row are devastating, which causes them to
evaluate trading methods and systems based on very shortterm performances.
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How To Make Big Money In The Exciting World Of Penny Shares
• Investors must be wary of losing confidence after a few
disappointing trades. Performance should be evaluated on
many trades and generally only after three years of results.
• Statisticians tell us there’s no statistical reliability to a test
unless you have 30 events to measure. The investor who
chucks his system after four losses in a row is doomed to spend
his trading career changing from one system to another.
• Once you’ve found the system that suits you best – stick to it.
• Remember, as a shareholder you actually own a small share in
the company and, as a result, you have every right to phone
the company concerned and request information.
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How To Make Big Money In The Exciting World Of Penny Shares
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How To Make Big Money In The Exciting World Of Penny Shares
6
Quips, Quotes, Tips and
Clips
• Penny shares are great for the private investor. The companies
are easy to understand and analyse.
• Remember, all of the giant monoliths on the JSE were once
fledgling penny shares too.
• Knowledge is power! Know and understand the company
you’re investing in. Understand its business model.
• Know at least the basics of human psychology. If you’re aware
of what makes the market tick, you’ll be able to get ahead.
• Know what the market as a whole is looking at. Generally, the
markets are always forward looking. The share price
anticipates, and factors in, tomorrow’s fundamentals now. It’s
always well worth looking at that little paragraph in the
earnings report headed “prospects”.
• Focus on value or at least potential future value.
• Look for vibrant exciting companies as opposed to miserable
has-beens!
• Be careful of who you listen to. Don’t take advice too quickly
if it contradicts your own research or “feel” for the company.
Be very wary of the opinions of those with vested interests.
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How To Make Big Money In The Exciting World Of Penny Shares
Many times you wouldn’t take advice from market
professionals, institutions and brokers in particular. We can’t
stress enough the importance of having a forward looking
approach to company fundamentals. Let us share some
examples. If we’ve seen this once, we’ve seen it a dozen times.
An institution or brokerage house will have their analysts put
out a report on a company that has just brought out results.
They’ll say: “These results aren’t good, we recommend a sell”
and the share price goes up! Well it’s all about the future. In
most of these cases, the bad results are the end of the bad
news and company guidance or prospects indicate better
things to come and the market reacts to that now, marking
the price up. Sometimes the opposite is true. A company can
come out with good results and the share price falls. As we’ve
said, it’s all about expectation and if the results were good but
below market expectation, the shares will decline.
• Look at the big picture. The sector in which the share is listed
will reflect the direction of most of the constituents of the
sector. If the sector as a whole is turning down, you can be
sure the shares within will go the same way. We can also look
at the related sectors in the US markets, since ours will follow
to some degree. Most of our penny shares are within the JSE
Small-Cap and AltX sector. The US equivalent is the S&P
600. Macro national economic fundamentals are also
important. For example, the retail sector benefits from a low
interest rate and low inflation environment. We also need to
consider the very important role of our currency. Gone are the
days when the levels of the rand and international currencies
play a back seat role in the market. In many cases, the rand is
the main driving force of the market as a whole and rand
hedge stocks in particular. When the rand is strong, rand
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How To Make Big Money In The Exciting World Of Penny Shares
hedge shares suffer. When the rand is weak, rand hedge shares
perform well. This can have very little to do with company
fundamentals, it’s simply a big picture item in the driving seat.
• As Warren Buffett says: “Be brave when others are afraid and
afraid when others are brave.” Again, this relates very much to
having a forward-looking view. An example: The tragic events
of September 11 2001 saw the US markets shut down for a
few days. When they reopened, the markets tanked and then
– while everyone was screaming in fear and terror, with blood
in the streets – the markets suddenly turned and began a long
strong bull market! Why? All because of a forward looking
view. The fearful were selling and the brave were buying their
shares.
• Don’t fall in love with your shares. Use them and lose them!
Don’t be afraid to cash in when your objectives have been
met. When a share goes against you, don’t be afraid to admit
the mistake, ditch it and get into something better.
• Don’t overtrade. If you get in and out of shares too often,
you’ll dilute your profits with brokerage expenses and give
yourself extra stress.
• Be patient. Sometimes things take a fair bit of time to make
substantial gains. A temporary downturn in the market is a
normal thing – ride it out.
• Ideally you should have eight to ten shares in your portfolio. If
you have too many, you’ll be more exposed to the overall
market and, therefore, unable to beat the averages. If you have
too few, your risk exposure is too great. If you want to take
advantage of a new HOT share, you might consider lightening
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How To Make Big Money In The Exciting World Of Penny Shares
up in some of your existing holdings, so as to keep within the
eight to ten range.
• Managing your portfolio. It’s always a good idea to keep a
proactive eye on your holdings. Keep your stop loss in place,
move it up behind the share and – when you trim your
portfolio – don’t sell your race horses. Sell the donkeys. Unless
your high flyers have reached your target, don’t sell them, let
the profits run and trim out the losers.
• If you believe in one company more than another, then hold
more shares in it.
• If you don’t see a good opportunity in the market at present
don’t trade.
• Markets are never wrong in the final analysis, so pay a lot
more attention to what the market is saying than to what the
madding crowd says. The bottom line is the share price and
not your or our opinions of what it should or should not be.
• Don’t ever believe a share can’t go any lower or higher.
• Ban wishful thinking!
• Accept failure and losses as a learning step to victory.
• Forget a loss quickly.
• Don’t take the market to bed with you. Clear your head
regularly!
• Try “paper trading” first if you’re new. When your confidence
has risen, move into the market.
• Strategy: Split your available capital into some for solid
growth shares and some for speculative recovery shares.
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How To Make Big Money In The Exciting World Of Penny Shares
• Strategy: Some like to re-invest 50% of profits, pocketing the
rest.
• Any fool can take profits, but a wise investor knows when to
take a loss.
• A weak heart and volatile shares don’t mix!
• Bears are more violent beasts than bulls. In other words, the
downside moves (fear) are faster than the upward (greed)
moves. A bear market takes back in one month what a bull
market took three months to build.
• Don’t allow failure (a loss) to discourage you.
• Don’t become complacent or over-confident and arrogant.
Humility before the market is a fine trait. It gives you clear
sight. Pride and arrogance blinds you. It’s far better to humble
yourself before the market than have it humble you!
• If you hesitate too long in “pulling the trigger”, the target will
have moved!
• Nothing new ever occurs in the markets. Human behaviour
repeats itself.
• Trading against the trend is like swimming against a surging
current.
• Don’t get blinded by the thrill of victory, be on your guard.
• Successful traders isolate themselves from the opinions of the
masses.
• Don’t average down on a losing share.
• The key to stock market profits is in managing your losses.
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How To Make Big Money In The Exciting World Of Penny Shares
• Be flexible and ready to change when circumstances demand.
• Trading success takes time, but is ultimately well worth it.
• Expect to succeed, don’t give up, endure, set high goals.
• It’ll cost you plenty if you think a share’s great and the market
doesn’t.
• How well you do will be related to how much time and effort
you put in.
• Knowledge pays the best dividends. Know yourself and know
your shares.
• Pessimists always lose.
• Relax, it’s only money!
• If an involvement in the stock market raises your blood
pressure, rather go and play golf.
• Aim at financial independence. People who just work for
money never get above their needs, but if your money is
working for you also, you have a far greater chance of getting
to that place of independence.
All the very best with your adventure into this wild and
wonderful world.
Regards,
The Red Hot Penny Shares Team
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How To Make Big Money In The Exciting World Of Penny Shares
Interested in expanding your
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How To Make Big Money In The Exciting World Of Penny Shares
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52
FSP Invest
Red Hot Penny Shares
Fleet Street Publications (Pty) Ltd
Private Bag X16, Northriding 2162
Registered in South Africa No: 1999/019170/07
VAT Reg No: 4430185282
ISBN 1 899964 69 X
R99.99
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