I am writing this piece on the once hot penny stock sponge tech Delivery Systems (SPNGQ: PK) for one reason, to try to get you to not only think rationally when buying equities but to also think outside of the box. Spongetech claimed to be a fast growing retailer of sponges. Their target market was kids, cats, and dogs. They had a brand name and Walgreen as a customer. Plus, it seemed like you saw the company almost every time you watched a sporting event. On the surface, this doesn’t seem too bad. Or does it?
Now, what did Spongetech longs miss in this play? We’ll it’s easy to say now, but at the time, between their product, and advertising campaigns, a case could be made for owning shares. I mean, even the New York Mets, Boston Red Sox, and New York Yankees advertised for Spongetech (All three are still owed money by Spongetech ).
Is it easy to spot the next Spongetech? No. However, most penny stocks scams that implode often have some the common symptoms. And I’ll touch on a few. The first being, do your homework and don’t dismiss negative information and articles just because you own the stock in question. And by no means am I saying to take some guys word on the Yahoo Finance message board as gospel. The sources have to be somewhat credible. In the Spongetech fiasco, The New York Post happened to be the source that hammered Spongetech. And guess what? The Post, along with a few short sellers with online followings happened to be right. So do your reading, time is your only expense.
Now there is a difference between investing and trading. Savvy traders can make money shorting the strongest stocks and buying the weakest. It doesn’t matter if it’s IBM or a penny stock, but most retail investors simply can’t. This is why if you have a time frame for a day, you should never own a stock that is accused of fraud, by even a somewhat credible source. The downside is just too big, and when a stock goes to zero, it wipes out other hard earned gains.
Another way to spot a red flag is to simply compare its sales to its market cap. If a company has a cure for AIDS or cancer and trades at 100 or 200 times sales that are one thing. But a company that sells sponges infused with soap is another. The lesson here is to just compare and contrast the penny stock you own to a larger more established company and just do some quick math. I realize some hot penny stocks trade at high price to sales ratios and often have high PE’s if they have any at all. But, after you check your stock versus a competitor, don’t be afraid to take a profit or even a loss, if the numbers are obviously far out of whack.
Lastly, and I’ll be brief with this one. Take a peek at the company’s financials, and if you can’t understand them, try and find somebody who can. That source might be a friend or an internet source. Once again, don’t take their interpretation as gospel, but factor it into your decision-making process. Especially if you are a novice. However, if these financials, smell fishy, sell the stock first and ask questions later. Can this way of thinking take some of your upsides off the table? Absolutely. But can it also save your account from getting blown up? The answer is yes. Remember there are plenty of trading opportunities out there. As a matter of fact, we just issued two consecutive profitable penny stock alerts to our subscribers in the last two weeks. A big component of making money in the stock market is sticking around long enough to make it.