How do you know when a penny stock is undervalued or overvalued? If you are new to penny stock trading this is very important. The difference in your timing of getting into a penny stock can be either huge gains or huge losses. Thestockwizards.net prefers the huge gains.
What we are going to do today is look at a few examples so you understand when you should be getting in a stock or getting out of a stock. We are talking about penny stocks not big board stocks in these examples just to make that clear.
Let’s use some examples of penny stocks that made huge gains in 2009. This was a year of biotech, medical equipment and pharmaceuticals in the penny stock arena.
The first stock that we will talk about is the one that would’ve made us all rich and well-off, if we just had 20-20 hindsight.
VRMLQ: This is a stock that was a life changer for a few traders in the penny stock world. The stock went from .05 to as high as $23, that’s right $23. Now you are wondering what made the stock go so high
1- VRMLQ is a biotech stock
2- VRMLQ had great news
3- The last and most important aspect of the whole article, the company had an outstanding share count of 5 million shares, that’s right 5 million. What does this mean to traders and investors? Why is it so important?
If you learn just one thing about trading penny stocks it’s Market Capitalization. Most penny stocks have no revenues, most will never have any earnings to justify a high price and maintain a high price. So we evaluate companies based on market cap or market capitalization.
On September 11th VRMLQ (of all dates 9/11), the company announces the following:
U.S. Food and Drug Administration Clears Vermillion’s OVA1(TM) Test to Determine Likelihood of Ovarian Cancer in Women with Pelv.
The stock went from .05 and closed at 1.29 for the day. In terms of market capitalization, the stock is at only a 5 million dollar market cap. Let’s stop right here and talk about how if a stock is overvalued or undervalued based on TheStockWizards.net guidelines.
TheStockWizards.net uses a guideline of $40 million as a reference point (equilibrium) for market capitalization. When any penny stock is trading at a $40 million market cap we have to take a serious hard look at the stock at that point in time. So if we use a guideline of a $40 million market cap in the example of VRMLQ you can see that at a $1.00 it only has a market cap of $5 million which is still very undervalued based on our $40 million dollar guideline for penny stocks.
When we saw that the share structure was only 5 million shares outstanding we knew the stock could easily go to $10 based on that kind of news. So here’s a stock that goes from .05 to $10 ($50 million market cap) in the matter of roughly 3 weeks. At its peak it hit a market cap of roughly $100 million.
VKNG: Here is another stock that was a life changer for some traders and again the reason why it ran big was very simple. The market cap was very low. On October 29th Viking Systems was trading at .0030, the low of the day, and on November 18th it hit an intraday high of 1.10. That’s right, in three weeks it ran up to a 1.00 from .003. Again you’re thinking how could a stock go that high that fast. As you can see the stock started out as a sub penny stock.
It boils down to a couple of things: share structure + being in the right sector at the right time + being very undervalued. The share structure of Viking Systems was $40 million shares outstanding. Which meant based on our guideline of a $40 million market cap that we use at TheStockWizards.net we felt the stock could go to a 1.00.
At a $1.00 the stock hit our 40 million market cap target right on the money. And you could see the stock sold off after that.
Smart traders recognize an undervalued stock in a hot sector and take full advantage of it. The stock caught fire and absolutely exploded in a three-week period.
This is the reason why people play penny stocks. All you have to do is hit a couple of these and it can change your financial situation in her hurry.
NEPH: here is another biotech play that had a lot of hype (forward-looking event) and the stock exploded to the upside in a big way. The stock went from .10 cents on May 19th all the way to an intraday high of $2.63 on August 20th. Again you’re probably saying how can the stock go so high so fast?
1-it had a forward-looking event (FDA approval hype)
2-it had the right share structure with an outstanding share count of 40 million shares outstanding. So at a $1.00 the market cap was 40 million,
The stock went as high as $2.00 which had a 80 million market cap at that point .
When evaluating companies based on market capitalization there a few other considerations to make when the company that you are investing in has a high market cap. There can be some compensating factors.
Let’s talk about compensating factors.
Traders and Investors use compensating factors such as revenue stream and earnings in stocks they are holding that have high market caps. These compensating factors can keep a trader or investor in the stock until something changes.
IMGG: Here is a stock that we feel that got a little bit ahead of itself. With an outstanding share structure of $375 million the stock traded as high as $2.00. The stock definitely got a little bit ahead of itself having a market capitalization 750 million at that point. And as you can see most profit takers and short-sellers agreed with us as the stock got hit hard and pulled back.
The stock ran up on a forward-looking event (FDA approval) pending so that brought a lot of excitement and anticipation into the stock. Once they get FDA approval, everything can change in a hurry, but to support a $750 million market cap they will have to have earnings and revenues and most traders know that. Also, there’s been speculation that the company could get bought out.
Looking For Confirmation
The Rat Pack: Traders and Investors are not the only players in town we also have what’s called Market Makers, maybe some of you guys have heard of them. Market Makers are traders as well. They supply liquidity to a stock on a daily basis on thousands of stocks. With penny stocks we noticed especially when a stock is over .50, that a certain group of market makers will come into a stock which we call the Rat Pack These Market Makers are seeing the same thing as many smart traders are when a stock is getting very overvalued based on market capitalization.
We have identified the Rat Pack as follows: CHDN SSGI PUMA NOBL LFCM STXG. When a penny stock especially when it’s over .50, you begin to notice the Rat Pack starts to swarm or move in for the kill. They know and you know especially when a stock is heavily promoted and has a very high market cap they will come in and try to make their money all the time from the short side.
We have seen this on many stocks time in and timeout. So if you see the Rat Pack on your level 2 screen starting to show up it’s because there’s a major pump going on and also Traders know the market cap is way out of whack. These guys are smart and will take advantage of it. It’s very easy for these guys to short a stock because of who they are.
We don’t have access to the same tools as these guys but we have been told that there are a couple of brokerage firms out there that will allow you to short penny stocks. One of them is Interactive Brokers and the other one is Sink or Swim. You can verify it yourself.
Again, all we’re trying to accomplish as successful traders and investors are figure out when a company is either undervalued or overvalued using our methods.
This is just a rough guideline, everybody has their own guidelines but we feel comfortable with what we use.
NPHC: the last company we will mention in this article is Nutra Pharma Corp.
In this case, we saved the best for last! This is a great scenario to use in the category of compensating factors when trying to put a value on the stock.
Nutra Pharma Corp., from a market capitalization standpoint, has $269 million shares outstanding with a market cap of around $100 million. If we use our guideline of $40 million market cap as our equilibrium point with no revenues this company would be overvalued. Nutra Pharma is a pharmaceutical stock so it’s in the same category as all the other stocks that we’ve been talking about and a hot story.
The company just launched Cobroxin Cobroxin.com, a OTC treatment for chronic pain. Cobroxin is the first OTC pain reliever clinically proven to treat stage 2 (moderate to severe) chronic pain. The drug which was developed by Nutra Pharma’s wholly-owned drug discovery subsidiary, ReceptoPharm, is available as an oral spray for treating lower back pain, migraines, neck aches, shoulder pain, cramps and neuralgia and as a topical gel for treating joint pain and pain associated with repetitive stress and arthritis. The Company also recently announced that they have successfully submitted the final packaging and labeling to the food and drug administration (FDA) to begin selling Nyloxin OTC, a similar but stronger treatment for moderate to severe stage 2 pain, and Nyloxin RX Nyloxin.com, a prescription treatment for severe (stage 3) chronic pain. What’s amazing is that these treatments are non-addicting and do not rely on the use of opioids or acetaminophen for their pain relieving action.
These products are finally going to bring revenues and earnings to the bottom line of the company. They were just launched so we are waiting for the revenue numbers to come out in the next few months. Once the revenue numbers are announced it will give investors and traders guidance on how to properly value the stock. So even though the market cap on the stock is a little bit high, there are compensating factors in the wings that can justify the high market cap.
If these products produce the revenue that we think they can, this could easily be a $1-$2 stock in a hurry. The stock is currently trading between .30 and .35 cents. So we continue to follow this story and watch it unfold in the pharmaceutical sector. This could be one of the big pharmaceutical plays of 2010.
In summarizing today’s lesson:
We are trying to figure out if the stock is overvalued or undervalued at the time we are interested in investing or trading the stock.
We will always analyze the market capitalization before we enter any stock and will just not jump in blindly.
To find out what the outstanding shares are on a OTCBB company, all you have to do is go to the company’s 10-Q filings. If it’s a pink sheet company in most cases you will either have to rely on other investors or traders for that information, or you will have to call the transfer agent. Pinksheets.com is a great website for information on pink sheet stocks.
Use 40 million as an equilibrium indicator when you are analyzing a company for undervalued or overvalued situations. We love when the company has a share structure outstanding of 40 million or less. We get really excited, especially if it has a hot story.
Remember, if there are compensating factors such as earnings or revenues, a higher market could be justified. Also we used these market cap guidelines only for penny stocks. We do not evaluate big board stocks the same way. Just want to make that clear.
Also look for the Rat Pack market makers for confirmation when a stock is hitting a very high market cap. These market makers start shorting and can sometimes take control of a stock.
We hope this helps the trading and investing community.
TheStockWizards.net will always try to bring you the best articles on the street on how to play penny stocks safely and profitably .