Beating the market with long-term selectivity in penny stock investing

Promises to beat the market fill penny stock investing media. Others caution to stay away from penny stocks all together. In most cases, promises of superior gains are too good to be true, especially when lacking transparent methodologies for identifying and profiting. But, penny stock investing can yield reliable profits.

In The Intelligent Investor, Benjamin Graham says that beating the market is no small task. To beat the market consistently, he describes, "The investor must follow policies which are:

1. Inherently sound and promising, and
2. Not popular on Wall Street."

This is true for penny stock investing.

Inherently sound and promising

Having a well-defined and time-tested approach to penny stock investing is important for success. Let's first look at an approach to identifying and managing a penny stock portfolio. Then, we'll look at the result of this approach.

Approach to Penny Stock Investing

Having a clearly defined system for identifying good opportunities is key to being successful. For long-term investments, fundamental analysis is best. To determine whether a company continues to create value for shareholders, it's best to consider:

1. Industry - a company worth considering must be in an industry worth considering
2. Sales - the company needs to be selling something and that sales number should be growing
3. Profit - the growing sales should translate to profits that are growing too
4. Assets and liabilities - the company should manage its financial resources well with decent assets and minimal liabilities, this will drive strong value metrics, including book value

Curious about what ideal numbers in each of these categories look like? We devised the Bowser Ratings System that has withstood the test of time that defines clearly what we look for.

Finding the companies isn't enough. An investor must also have a system for entering and exiting these stocks. There are many different approaches to penny stock investing. The best method is the one that suits your investment style.

An example is buying on a pullback to a key historical support zone, selling half when the stock doubles and the remainder on a pullback of 25%. Risk is a 50% drop without hitting the first target (double). This, in essence, is the Bowser Game Plan.

Results of This Penny Stock Investing Approach

As an investment newsletter, we continually measure the success of our picks. One of the ways we do so is through our Annual Historical Review. Since 1976, 462 of 694 (67%) of our recommendations at least doubled from our recommendation.

To measure what that means in practice, Subscriber Roger Otting conducted a study comparing the gains of stocks selected using the criteria listed above with the strategy detailed above (without using key support as a buying target). Based on picks from 2017 to 2019, a portfolio would've appreciated 259%. This includes $44,673 in realized profits.

Investing into the iShares Russell 2000 ETF (IWM) would have resulted in a 40% return (not bad) with just $1,296 in realized profits (from dividends).

This is the same selection system and investment strategy that we have used since our inception in 1976, showing they both stand the test of time.

Lack of popularity

The second point of Graham's is popularity. Unpopularity leads to hidden value.

In order to examine the popularity of penny stocks versus the rest of the stock market, we'll use institutional ownership as the gauge. Typically, institutions are described as "smart money." So, companies with high institutional ownership are popular on Wall Street, and those with low institutional ownership, unpopular.

To demonstrate major stocks, we'll use the Dow Jones Industrial Average (DJI), the index of the 30 most prominent publicly-traded companies. The average institutional ownership of stocks on the DJI is 71%.

To demonstrate penny stocks, we'll use Bowser recommendations trading under $5 per share, which is the SEC's definition of what makes a penny stocks. The average institutional ownership of Bowser recommendations is just 16%.

Using institutional ownership, penny stocks (even those that have passed through the Bowser Rating System) are far less popular on Wall Street. This means that there is untapped value an investor can profit from.

Conclusion

Per Graham's assertion it's possible to beat the stock market reliably, but it isn't easy. It takes a system for identifying stocks in the right unpopular niche and then devising a system to profit from them.

Penny stocks are unpopular, and that's good. However, the investor must develop a new system or use an existing system for identifying and profiting from penny stocks.

A great place to start is using key fundamental factors to filter out poor investment ideas and then looking at patterns in how these stocks behave. This is something that we do regularly at The Bowser Report to help our subscribers profit from penny stock investing.