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What should you look for when picking penny stocks?

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Quick Answer

When picking penny stocks, investors should evaluate a company's state in respect to dilution, the share price and valuation as depicted in outstanding shares, and the economic sector the company operates in, notes Investopedia. Investors should look deep into a company's fundamentals before trading in pennies.

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Full Answer

Penny stocks refer to stocks with low share prices, usually less than $1, explains Investopedia. Penny stocks may be cheap and affordable, but they don't necessarily guarantee huge returns. Before investing in a particular penny stock, it is important for investors to calculate a company's outstanding shares, which refer to all stock currently held by all unitholders.

Dilution occurs due to stock splits, issuance of shares to raise capital and employee stock options, which may result in lower ownership percentage of the share stock, notes Investopedia. Consistent issuance of shares reduces the value of each share held by an investor. Investors should avoid companies that are prone to regular dilution.

Market capitalization determines the size of a company, and many investors assume that companies trading in penny stocks are relatively small, but this may be wrong, according to Investopedia. Potential investors should evaluate a company's essentials thoroughly, including source of capital, competitive advantage in the market and profitability of the company. Highly competitive economic sectors, such as the metals and mining sector, attract many companies that sell penny stocks, and this may cause firms to search for more investors to fund operations, which may lead to dilution.

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