Blog : Some Ways to Predict Penny Stock Success (or Failure)

by Ed Zwirn on March 27th, 2013

ipo in penny stocks

Penny stocks are of course perceived as a more risky investment than stocks in larger companies, especially when they make their market debuts.

But a penny stock that has just hit the market with an initial public offering is in fact less likely to go belly up than its higher-priced peers. According to a study by Cecile Carpenter and Jean-Mark Suret of Quebec's Laval University, the failure rate for IPOs on Canadian exchanges, which have lower share price listing requirements, is "surprisingly lower" than in the U.S.

To reach this conclusion, Carpenter and Suret looked at 2,373 IPOs that hit Canadian exchanges from 1986 to 2003. Eighty-six percent of these new issues were penny stocks, nearly half (45%) had no revenues at all at the time they went public and a whopping 71% were not yet profitable. Penny stocks that were eventually delisted were deemed failures, while success was measured by graduation to a more senior exchange.

"The failure rate of these microcap IPOs is surprisingly lower than the one observed in the U.S. for larger IPOs," they write.

On the other hand, success, i.e., the possibility of scoring a big hit from your penny stock investment, can be predicted by several factors, including the company's size, the industry it is in and market conditions.

According to the research, another indicator to check out is the involvement of venture capitalists--people with deep pockets--in your penny stock.  "Prestigious intermediaries involved in the IPO process decrease the failure rate and increase the success rate," Caprenter and Suret write, observing that the failure rate for VC-backed issuers is less than 50% of that of non-VC-backed issuers (22.07% vs. 50.56%), while the success rate more than doubles when venture capitalists are involved (28.97% vs. 12.64%).

Not surprisingly the success or failure of a penny stock was found to vary greatly depending upon the sector in which its company was doing business, with 63.22% of energy issuers surviving and 18.39% hitting big. This is not surprising given the runup in oil prices which occurred during the period.

For high-tech issuers, the success rate was found to be 21.9%.

Another penny stock risk factor identified by the professors is the period of time in which the IPO takes place. Does everybody and his brother seem to be coming up with a new stock offering at the moment? If so, the chances are better than half (54.45%) that your penny stock will go under, a fact which they attribute to "lower investor rationality during hot issue periods."

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