It doesn’t take many smart penny stock plays to make a lot of money, either. If you bought shares of Wal-Mart in the early 1970s, you would have paid only about 5 cents a share. Adding up the regular dividends, stock splits and rampant growth over the years, this one investment would easily make up for two or three decades of strikeouts.

This is how you have to play the penny stock market in order to be successful. You have to swing for the fences and let your big winners make up for any bumps you may encounter along the road. But the difficult part is how you find these home runs.

In the world of smaller stocks, it sometimes takes a lot more than simple valuation to measure a company’s potential. After all, a lot of these small companies aren’t even turning a profit…yet. The trick is to pick out the ones that will, while avoiding the ones that could just be poison to your portfolio.

Luckily, there are some very tangible factors you can use to evaluate how well some of these super-small stocks can perform.

Here are the criteria I use to help me find quick-growing penny stocks everyone wants to get their hands on so badly:

1. Revenue Growth: Many great, undiscovered penny stocks probably won’t be making steady profits yet, but they should still be growing revenues like wildfire. Ideally, better margins and profits should follow as the business strengthens. The more a company grows its revenue, the closer I watch it. And when it comes to stocks that trade for less than $4 and $5 a share, its not totally uncommon to see 25%, 355 or even 50% revenue growth over the course of a year.

2. Profit Fortress: It’s always a good idea to find unique companies that possess some type of “unfair advantage” over the competition. Any business that churns out an ordinary product will eventually lose out to a company that can do it better, faster and cheaper. The most successful companies operate businesses that may have some type of government protection or products and services that aren’t easily duplicated.

3. Black Cloud Factor: Sometimes, one or two problems that are weighing down a company’s stock can help you scoop up shares cheaply. Other times, it’s uncertainty about the outcome of a lawsuit or regulatory issue that weighs the share price down. However, if the company’s underlying business is solid, the share price should go up once Wall Street’s uncertainty is resolved.

4. Profit Catapult: A profit catapult is a future event that will drive a company’s growth. Everyone hears about future prospects for many of the blue chip companies, but many times, investors ignore potential good news for penny stocks. A profit catapult for a small biotechnology company could be an action date by the FDA to approve a new drug. An approval of a company’s first drug is a major step on its way to becoming profitable –and it’s first step toward making shareholders big profits.

5. Business Shock Factor: The business shock is simply how revolutionary a company’s product or service could be. The great businesses of our time will possess “disruptive technologies” that could potentially change the marketplace as we know it. This new technology will be patented or very difficult for other businesses to duplicate, giving our technologically advanced penny stock yet another unfair advantage.

I’ll write more next week about how I’ve used these guidelines to find some great fast-growing penny stocks.

Best,
Gunner
November 27, 2006

P.S.: There’s a little-known company that’s working on an energy breakthrough. It’s cheaper, more plentiful and safer than gasoline. Yet this new “designer fuel” packs enough punch to gas up every single truck, car and diesel engine train in America…for the next 811 years.

Fast-Growing Small-Cap Stocks was originally featured in the Penny Sleuth.