A couple of months ago, I came across a new academic paper about a strange anomaly in the market for penny shares.
It looked interesting so I printed it out, read the abstract… then dumped its fifty-odd pages onto the pile of unread printouts at the corner of my desk. And that’s where it stayed for about two months.
It turns out the printout was kind of important (yes, I eventually read it!).
It’s important enough that it’s the first thing I want to tell you about in my first email as editor of this newsletter.
But before I get to it, I’d like start from first principles. I want to lay out everything we know about penny shares. The insights from this paper will make a lot more sense after I do.
What do penny shares do?
Let’s get it all out on the page, the good and the bad. Certain penny shares – the “superstars” – can single-handedly transform your wealth. These stocks go up by 5, 10 or even 50 times over…
But it’s not easy to find the superstars. For every superstar, there’re perhaps four junk shares which go nowhere
Penny shares are risky – if you’re not careful, you can lose what you put in
You don’t need much money to get started investing in these companies
The best penny shares can take off, even when the economy is bad…
But penny shares as an asset class tend to go in the same direction as the overall stock market
Penny shares can be more expensive to trade – broker fees can be high
Penny shares can be “illiquid”, which means that it can be hard to get the best possible price for your shares if you want to sell out in a hurry.
If you’ve been investing in penny shares for a while, you’ll know a lot of this stuff. But it’s worth getting it all out there.
I want to throw in a few more ideas too, from the world of academia. What do the Nobel Prize winners of this world have to say about penny shares?
On average, the evidence shows that penny shares massively outperform the stock market…
And on average, the smallest penny share companies massively outperform the merely small ones.
This “bonus” enjoyed by investors in small companies is called “the small company effect”. It was first uncovered back in 1983. (The small company effect is absolutely massive: $1 invested in big companies in 1955 would make you $3919 by now. If you’d invested in small caps, you’d have made $29,400. And if you invested in the smallest small caps, you’d have made $48,090!)
But the small company effect is a slippery bugger! It seems to be concentrated in particular types of small companies, in particular times of the year, and in shares that are hard to trade.
And certain types of penny shares massively underperform. Seasoned penny share investors will have come across a few of these in their time. The junk.
I’ve been trying to disentangle all these ideas for months now… trying to work out a way to put them to work for ordinary investors like you. I’ve been studying the history of superstar penny shares, and the historical data from the overall market, and the theory behind the data.
A slap on the forehead
It was all coming together, bit by bit. Then I remembered that academic paper, still unread on the corner of my desk. I picked it up again and started to read through it, this time more carefully. I began to take in what it was saying. About halfway through reading it, I swear, I literally slapped myself on the forehead.
It turns out this “working paper” (it’s new, so it still has to go through refereeing process before it gets published in an academic journal) is saying something very important.
It’s written by a professor from one of the world’s most respected finance departments, along with statisticians from a $20bn hedge fund. Using data going back more than six decades, in dozens of different markets around the world, it shows the specific characteristics to look for in superstar penny shares.
And more to the point, it shows you how to pick out superstars ahead of time. It doesn’t stop there. This system shows how: To harness the “small company effect” to aggressively boost returns across your entire portfolio
To rid yourself of “junk” shares, the bane of every penny share investor
To save money on brokers’ fees – why pay more than you need to?
To find superstar companies in all kinds of different industries. So if one sector hits the rocks, you’re protected
To ramp up your risk level to make more money
To invest in high-octane “growth companies”
To profit from penny shares whether the FTSE is going up or down.
These are big claims. I know they are!
But I’ve been studying this area for a while now. And I have to say, this system makes perfect sense in light of everything else I’ve learned.
It resolves some of the biggest “puzzles” in the world of penny share investing – like, for example, why many seemingly excellent penny shares under perform. Or why penny shares seemed to do particularly well in certain months of the year. And, most importantly of all, it proves that the “small company effect” is real, and it’s big, and that it’s possible for ordinary investors to profit from it.
The state of play
So here’s where I am now: I’m working with a software provider to build a system. The software’s job will be to scour the markets and separate the superstars from the junk, along the lines described in the paper. I’m going to use it to find superstar penny shares, and write about my findings every month in my paid newsletter.
This system is going to give me a massive leg up on the competition, I’m confident of that. But it’s not going to be the be-all and end-all of the newsletter. Yes, it’ll be my most important tool. But it’ll still just be a part of my stock picking method.
I’ll be writing to my paid subscribers to explain everything in more detail over the next few weeks.
And dear Penny Sleuth reader, I’ll keep you in the loop too. For now, the paid newsletter is closed to new subscribers. But I plan on opening it up again in the next few months.
p.s. I’d be interested to hear – what do you think are the characteristics of superstar penny shares? Let me know at [email protected].