Investors looking to add to the aggressive portion of their portfolios may turn to the higher-risk strategy of buying speculative Canadian penny stocks.

However, there are several big risks that can occur when investors venture into penny stocks.

Keep in mind that investing is different from many other pursuits in one crucial way: doing the wrong thing as an investor can actually make money for you, but only temporarily.

Buying low-quality penny stocks is one of those things that can appear to be successful before it goes badly wrong. Some get hooked on it, since low-quality stocks can be highly profitable over short periods. That’s because they are generally more volatile than high-quality stocks.

Here are 2 of the biggest risks you face when you invest in penny stocks of dubious quality:

1. Low-quality penny stocks are quick to fall when a bubble bursts: A decade ago, buyers of Internet start-ups made far more profit than investors who stuck with well-established companies. The same thing happened when many investors bought low-quality resource stocks in 2007 and 2008, and it has happened in the past in penny stock bubbles. When the bubble bursts, however, prices of low-quality stocks inevitably come crashing down. After all, it’s much easier to launch a stock promotion than it is to create a successful, lasting business.
   
   Penny stocks tend to be more speculative, and are engaged in such things as finding mineral deposits that can be mined at a profit, commercializing an unproven technology or launching new software.

Do you have part of your portfolio that you play with? The part you're willing to be a little more aggressive with? Then let me recommend my Stock Pickers Digest newsletter. You get the stocks my proven Quick Profit/Value System ™ has identified as having the potential to give you 50% gains — or more — in 6 months or less. Click here to learn how you can get started right away.

2. The longer you play, the likelier you are to lose: If you lose money in speculative or other low-quality stocks (or funds that invest in low-quality stocks), you may think your main mistake was bad timing. That’s a misconception. You can get lucky in penny stocks, just as in lotteries. But if you play long enough, the “house odds” eventually triumph over any run of luck. In penny stocks or games of chance, the odds are against you. So, time works against you. The longer or more often you play, the likelier you are to lose.

Canadian penny stocks: Make penny stocks a small portion of your portfolio

Ultimately, penny stocks should always be a small part of any diversified portfolio. They should be bought with money you’re willing to risk.

For the bulk of your portfolio, you can put the odds in your favour by following our three simple rules: Invest mainly in well-established companies, spread your money across the five main economic sectors (Manufacturing & Industry, Resources & Commodities, the Consumer sector, Finance and Utilities), and avoid or downplay stocks in the broker/media limelight.

This puts time in your favour. The longer you stay invested, the more likely you are to come out ahead.

If you’re looking for stocks that suit the more aggressive portion of your portfolio—stocks that have the potential for gains of 50% or more in 6 months or less—you really should subscribe to Stock Pickers Digest.

The latest issue of Stock Pickers Digest gives you our full analysis, including clear buy/sell/hold advice, on 20 stocks that you can hold in that part of your portfolio you devote to aggressive investing. What’s more, you can save $50.00 off regular annual subscription rate as a new subscriber. Click here to learn how.

Buying penny stocks can lead to a big payday when you make the right choice. But the odds against success are high. Penny stocks are almost always involved in riskier ventures, such as finding mineral deposits that can be mined at a profit, commercializing unproven technologies or launching new software.

What’s more, it’s much easier to launch and promote a stock than it is to start a successful business. So penny stocks attract more than their share of unscrupulous operators and stock promoters.

Buying penny stocks: Be wary of promotional publicity

Penny stock promoters love to make deals with major, household-name companies. They’re convinced the public is far more likely to buy penny stocks that have agreements with Teck Resources, BHP Billiton or another major mining company to finance exploration of their mining claims.

• Major company involvement is frequently exaggerated: When promoters manage to make a deal with a major firm, they often go to great lengths to make it seem bigger than it is. Instead of announcing that the big company has invested, say, $50,000, a stock promoter may issue a press release saying the two companies have entered into a “multi-stage development plan.” The release may say the major company has agreed to spend “up to $10 million” or some other exalted figure. It will usually provide a toll-free number or web address for investors to order or download the glossy brochures.

Do you have part of your portfolio that you play with? The part you're willing to be a little more aggressive with? Then let me recommend my Stock Pickers Digest newsletter. You get the stocks my proven Quick Profit/Value System ™ has identified as having the potential to give you 50% gains — or more — in 6 months or less. Click here to learn how you can get started right away.

• Big companies have far more bargaining power than individual investors: It pays to remember that a big company doesn’t go into a situation like this the same way you do. If the big company agrees to spend $50,000 to study the mining property, new technology or pioneering program, it will also insist on a series of options that let it invest ever-larger sums on favourable terms. But the big company will always reserve the right to drop out and cut its losses. In most cases, it will exercise that right.
  
  A major mining company will gladly spend $50,000 one hundred times, and lose every penny of it — a total outlay of $5 million — if this means it will get a chance to develop the one rare project that’s ultimately worth an investment of, say, $500 million. If it waits till the property, technology or program has proven itself, development rights will be far more costly. So it gets in early by investing what are really just token amounts of money for a major firm. That’s why big-company involvement by itself is never a good reason to buy penny stocks.

Buying penny stocks: 4 more keys to smart investing

In addition to avoiding Canadian penny stocks that promote themselves too aggressively (or do so misleadingly) here are 4 more things we look for when we analyze penny stocks for Stock Pickers Digest, our newsletter for aggressive investing.

1. We want to see experienced management with a proven ability to develop and finance a mine.
2. We look at environmental constraints in places where junior mines are exploring for minerals. In Europe and certain parts of the U.S., junior mines need a particularly rich find to justify the costs of overcoming environmentalists’ objections.
3. When we recommend junior mines that only explore for minerals, we prefer those that operate in an area whose geology is similar to that of nearby producing mines.
4. We think you should avoid stocks that trade over the counter, where such things as regulatory reporting are lax.

If you buy penny stocks or other aggressive investments, you really should have a subscription to Stock Pickers Digest. You can save $100.00 off the regular rate with our introductory subscription (exclusively for new subscribers). The latest issue gives you our very latest analysis—and clear buy/sell/hold advice—on 20 stocks that may be suitable for the part of your portfolio you devote to aggressive investing. Click here to take advantage of our special subscription offer.

When Yellow Media first sold units to the public in 2003, many investors thought Yellow was a well-established company. In fact, it was more like an unwanted, over-the-hill business. In our view, it was just another new issue.

As long-time readers know, we advise staying out of virtually all new issues. They come to market when it’s a good time for the company or its insiders to sell, and that almost always isn’t a good time for you to buy.

Over the last few years, we continued to recommend avoiding Yellow. We pointed out that it gave its product away for free, and relied on ad renewals from professionals such as lawyers and dentists, and from merchants and local service providers such as movers. Selling ads in printed directories was increasingly difficult as more and more people used the Internet instead.

Even at today’s distressed prices, Yellow exposes investors to a great deal of risk. We still advise against investing in it.

For example, an Inner Circle member interested in buying penny stocks recently asked our advice on North American Tungsten. The company’s projects are located in the Northwest Territories and Yukon Territory. Tungsten is used in a wide range of products, from wind turbines to light bulbs.

To give you a sense of how my Inner Circle service works, I’d like to share this question about buying penny stocks, and our answer, with you. I hope you enjoy and profit from it.

Q: Pat: Can I have your opinion on North American Tungsten? Thanks.

A: North American Tungsten, $0.36, symbol NTC on Toronto (Shares outstanding: 187.0 million; Market cap: $85.4 million; www.northamericantungsten.com), acquires, explores, develops and operates mineral properties (mainly tungsten) in the Northwest Territories and Yukon Territory. The company owns the producing Cantung mine, as well as the Mactung project.

The Cantung mine has the potential to generate about 4% of the world’s tungsten production. The company believes that the Mactung deposit, which could be in production in a few years, has about 10% of the world’s known tungsten resources.

Low tungsten prices forced the company to suspend operations at the Cantung mine in October 2009. It restarted Cantung in October 2010.

Do you have part of your portfolio that you play with? The part you're willing to be a little more aggressive with? Then let me recommend my Stock Pickers Digest newsletter. You get the stocks my proven Quick Profit/Value System ™ has identified as having the potential to give you 50% gains — or more — in 6 months or less. Click here to learn how you can get started right away.

Tungsten has many uses, including as tungsten carbide in cemented carbides, which are wear-resistant materials used by the metalworking, mining, oil and construction industries.

Tungsten wires, electrodes and contacts are used in lighting, electronics, heating, and welding. As well, tungsten is used to make heavy metal alloys for weapons, radiation shielding, and weights. It is also used to make superalloys for turbine blades, tools, and wear-resistant parts and coatings.

Large amounts of tungsten are used in incandescent light bulbs, but governmental energy-saving regulations are forcing these bulbs off the market. That has hurt tungsten demand. However, tungsten also goes into halogen lamps, and into electrodes for discharge lamp systems (such as compact fluorescent lights). Demand for these types of lights is rising. So far, this has mostly offset lower tungsten demand from incandescent light bulb makers.

The company does not have positive cash flow, so it recently had to raise $11.5 million in a share issue at $0.50 each to fund its operations.

Our buy/sell/hold advice on North American Tungsten, based on the company’s current financial position the outlook for tungsten demand, is only available to members of our Inner Circle. You can’t get it anywhere else! (Note: If you are a current Inner Circle member, please click here to view Pat’s recommendation. Be sure to log in first.)

Let my trusted advice help guide you through the coming critical years

When you become an Inner Circle member, you always have access to me and my investment team. Whether you’re looking for investment strategy or a trusted second opinion on whether you should buy, hold—or sell—a specific stock, my trusted advice is always a mouse click away.

In addition, you’ll not only receive the answers to your questions, but you’ll also get to see all other members’ questions, and our answers (of course, we eliminate any personal information).

Even if you don’t ask questions yourself, you’ll be surprised at what you can pick up by reading answers to questions posed by other investors just like you.

And that’s not all. You also get subscriptions to all 4 of my newsletters, The Successful Investor, Stock Pickers Digest, Wall Street Stock Forecaster and Canadian Wealth Advisor.

I urge you not to miss this opportunity. Give yourself an advantage over other investors and join my Inner Circle today. Click here to learn how.

For example, an Inner Circle member recently asked our advice on Gippsland Resources. The Australia-based penny stock’s two main properties are both located in Egypt, and contain deposits of tantalum, a rust-resistant metal with many industrial uses.

To give you a sense of how my Inner Circle service works, I’d like to share this question, and our answer, with you. I hope you enjoy and profit from it.

Q: Pat, would you have an opinion on Gippsland Resources, traded on the Australian stock exchange?

A: Gippsland Resources, $0.05, symbol GIP on the Australian exchange (Shares outstanding: 626.3 million; Market cap: $30.7 million Australian, www.gippslandltd.com), is focused on developing its 50%-owned Abu Dabbab-Nuweibi and Nuweibi tantalum/tin projects in Egypt. The Egyptian government owns the other 50%.

Rust-resistant tantalum is used to make light-bulb filaments, electrolytic capacitors (which are used in electrical circuits), lightning arresters (which protect electrical equipment from high voltage caused by lightning), nuclear-reactor parts and some surgical instruments.

Do you have part of your portfolio that you play with? The part you're willing to be a little more aggressive with? Then let me recommend my Stock Pickers Digest newsletter. You get the stocks my proven Quick Profit/Value System ™ has identified as having the potential to give you 50% gains — or more — in 6 months or less. Click here to learn how you can get started right away.

Tantalum prices have moved up lately, from $38 U.S. a pound in December 2009 to a recent high of $120 U.S. Higher sales of electronic devices are part of the reason for the price rise. But most of the increase results from U.S. government pressure on manufacturers to identify their tantalum sources. That’s because 35% of the global tantalum supply is believed to come from illegal, or “conflict,” mines in the Democratic Republic of Congo. Tantalum produced from those mines is commonly known as “blood tantalum” or “coltan.”

Tantalum prices may stay high in the short term, but higher prices will likely prompt producers to restart dormant mines and push forward mothballed development projects. That would lower tantalum prices in the long term.

Gippsland recently sold 80 million shares for $0.04 each. That increased the penny stock’s shares outstanding by 15%, and raised $3.2 million.

That’s enough to let Gippsland keep developing its properties, but the company will likely have to keep issuing shares at low prices to keep its projects moving forward. Operating in Egypt also entails above-average political risk.

Our buy/sell/hold advice on Gippsland, based on the prospects for the penny stock’s tantalum projects and the political situation in Egypt, is only available to members of our Inner Circle. You can’t get it anywhere else! (Note: If you are a current Inner Circle member please click here to view Pat’s recommendation. Be sure to log in first.)

If you’re looking for authoritative advice on investment issues, or fundamental analysis of investments—including penny stocks—you’re considering buying, you should join Pat McKeough’s Inner Circle. It’s Canada’s most exclusive investment group.

Inner Circle members always get clear, concise investment advice that’s 100% independent, and untainted by commissions or other undisclosed influences. We guarantee it. Click here to learn more.

CriticalControl gets about 60% of its revenue from clients in the oil and gas industry, followed by government (20%), health care (10%) and finance and retail (10%). About 45% of Alberta’s provincial-government ministries are clients. The company estimates that 85% of western Canada’s oil and gas firms use its products.

CriticalControl has two main divisions:

Energy Services, which provides 63% of CriticalControl’s revenue, helps oil and gas companies manage a wide variety of data, such as production volumes and flow rates from wells to processing facilities.

The Service Bureau Operations division (37% of revenue) provides registry services that include managing land titles, statistics and motor-vehicle information. This division also converts older paper and microfilm documents to electronic records.

U.S. diversification began in 2009

In November 2009, CriticalControl made its first U.S. acquisition when it bought GAS Analytical Service for $11.2 million. GAS makes software that gathers data and generates volume reports for natural-gas producers. The company has over 900 clients, including 80% of the top-25 gas producers in North America.

In the three months ended September 30, 2010, CriticalControl’s revenue rose 65.4%, to $11.7 million from $7.1 million a year earlier. Revenue at the Energy Services division jumped 162.5%, mainly because of the addition of GAS. Revenue rose just 1.5% at the Service Bureau Operations division.

The company’s earnings rose 28.3% in the quarter, to $853,000 from $665,000. CriticalControl issued shares to help pay down the debt it took on to buy GAS. Because of more shares outstanding, earnings per share were unchanged at $0.02.

The cash from the share issue helped Critical Control push down its long-term debt to $5.5 million (or a reasonable 17% of its market cap). That’s down from $8.3 million at the end of 2009. The company also held cash of $1.2 million, or $0.03 a share.

Small purchases cut acquisition risk

CriticalControl continues to expand through acquisitions. In November 2010, it paid $1.9 million for Ohio-based TSM Ltd., which provides natural-gas flow measurement services.

CriticalControl’s growth by acquisition strategy adds risk. However, it is mainly buying small companies. That cuts the risk of a big writedown against earnings if one of them fails to live up to expectations. CriticalControl is also purchasing companies outside Alberta. That helps lower its reliance on the province.

The company’s strong base of government business in Alberta provides steady revenue. There’s still room to grow in that province, and the company’s expansion into the U.S. and other provinces, such as Manitoba and Ontario, adds further growth potential.

CriticalControl trades at just 8.6 times the $0.08 a share it probably earned in 2010. That’s low in light of its expanding U.S. operations and growing client base.

CriticalControl is a thin trader, but it’s a buy.

Buying low-quality Canadian penny stocks is a mistake that many investors make. Some get hooked on it, since low-quality stocks can be highly profitable over short periods. That’s because they are generally more volatile than the high-quality stocks (the kind that have a history of earnings, if not dividends) that we recommend in our Successful Investor newsletter.

Here are 2 risks you face when you overindulge in Canadian penny stocks:

1. Low-quality Canadian penny stocks are quick to fall when the bubble bursts: A decade ago, buyers of Internet start-ups made far more profit than investors who stuck with well-established companies. The same thing happened when many investors bought low-quality resource stocks in 2007 and 2008, and it has happened in past in penny stock bubbles. When the bubble bursts, however, prices of low-quality stocks inevitably come crashing down. After all, it’s much easier to launch a stock promotion than it is to create a successful, lasting business.
   
   Penny stocks tend to be more speculative, and are engaged in such things as finding mineral deposits that can be mined at a profit, commercializing an unproven technology or launching new software.

Do you have part of your portfolio that you play with? The part you're willing to be a little more aggressive with? Then let me recommend my Stock Pickers Digest newsletter. You get the stocks my proven Quick Profit/Value System ™ has identified as having the potential to give you 50% gains — or more — in 6 months or less. Click here to learn how you can get started right away.

• Because success in these endeavours is rare, it’s all the more important to look for investment quality in penny stocks.

2. The longer you play, the likelier you are to lose: If you lose money in speculative or other low-quality stocks (or funds that invest in low-quality stocks), you may think your main mistake was bad timing. That’s a misconception. You can get lucky in penny stocks, just as in lotteries. But if you play long enough, the “house odds” eventually triumph over any run of luck. In penny stocks or games of chance, the odds are against you. So, time works against you. The longer or more often you play, the likelier you are to lose.

How our three-part investment strategy puts time in your favour

You can put the odds in your favour by following our three simple tsinetwork.ca rules: Invest mainly in well-established companies, spread your money across the five main economic sectors (Manufacturing & Industry, Resources & Commodities, the Consumer sector, Finance and Utilities), and avoid or downplay stocks in the broker/public-relations limelight.

This puts time in your favour. The longer you stay invested, the more likely you are to come out ahead.

You can get our latest analysis, including our clear buy/sell/hold advice, on dozens of Canadian stocks you may be considering buying in The Successful Investor. What’s more, you can get one month free when you subscribe today. Click here to learn how.

All best wishes from all of us here at tsinetwork.ca. We wish you and yours a terrific year-end holiday and a healthy, happy and prosperous New Year!

Today’s tip: “Beware of companies that are more interested in boosting their stock than in building their business.”

Penny stock promoters love to make deals with major, household-name companies. That’s because they think the public is far more likely to buy penny stocks that have agreements with Teck Resources, BHP Billiton or some other major mining company to finance exploration of their mining claims. Or if Sony, Apple or some other household-name multinational has agreed to evaluate their computer program or electronic gadget. The link with a major gives them instant credibility, especially with investors who buy penny stocks.

• Exaggerated involvement: When they get a deal with a major, promoters often go to great lengths to make it seem bigger than it is. Instead of announcing that the big company has invested, say, $50,000, a stock promoter may issue a press release that says the two companies have entered into a “multi-stage development plan.” The release may say the major has agreed to spend “up to $10 million” or whatever. It will usually provide a toll-free number for investors who wish to call and order the glossy brochures.

Do you have part of your portfolio that you play with? The part you're willing to be a little more aggressive with? Then let me recommend my Stock Pickers Digest newsletter. You get the stocks my proven Quick Profit/Value System ™ has identified as having the potential to give you 50% gains — or more — in 6 months or less. Click here to learn how you can get started right away.

• Big companies have more leverage: It pays to remember that a big company doesn’t go into a situation like this the same way you do, as an individual investor. If the big company agrees to spend $50,000 to study the property, program or gizmo, it will also insist on a series of options that let it invest ever-larger sums on favourable terms. But the big company will always reserve the right to drop out and cut its losses. In most cases, it will exercise that right to drop out.

  A major mining company will gladly spend $50,000 one hundred times, and lose every penny of it — a total outlay of $5 million — if this means it will get a chance to develop the one rare project that’s worth the investment of, say, $500 million. If it waits till the property, program or gizmo has proven itself, development rights will be much more costly. So it gets in early by investing what are, for it, token amounts of money. That’s why big-company involvement by itself is never a good reason to buy penny stocks.

• Good time to sell: In fact, when a penny stock shoots up on the news of big-company involvement, and the property/program/gizmo is still in the early stages of development, it’s often a good time to sell.

Next Wednesday, July 21, 2010, Investor Toolkit will give you a simple strategy for cutting your risk when investing in the stock market.

If you buy penny stocks or other aggressive investments, you really should have a subscription to Stock Pickers Digest. The latest issue gives you our full analysis, including clear buy/sell/hold advice, on 19 stocks that may be suitable for the part of your portfolio you devote to aggressive investing. What’s more, you can get this issue free. Click here to learn how.

Recently, we received a member question about Cobra Oil & Gas Co. (the company has since changed its name to Viper Resources Inc., symbol VPRS on the Nasdaq bulletin board). The company trades on the U.S. over-the-counter market, which some investors see as a good place for buying penny stocks. (See below for more on how the over-the-counter market works.)

The shares were trading at $0.46 when we advised our member to avoid them in late October. They’ve since lost more than half of their value, and now trade at $0.21.

This is a good illustration of the kind of clear, concise advice you get when you join my Inner Circle service, so I’ve posted the original question, and our response, below. I hope you enjoy and profit from it.

Q: Hi Pat. A friend of mine has recommended Cobra Oil and Gas Co., saying his broker has a target price of more than $10.00 on this penny stock. What is your opinion?

A: Cobra Oil & Gas Company (Shares outstanding: 76.9 million; Market cap: $35.4 million), aims to explore for oil and natural gas in Utah and Montana. The company began trading at $0.50 a share in May 2008.

In Utah, Cobra’s main assets are a 40% interest in oil-sands leases in Uintah County. These consist of 33,632 acres, plus a 37.5% interest in roughly 640 acres with oil and gas drilling rights. The company also has a 100% interest in 82,000 acres in the Williston Basin of Valley County, Montana. No drilling activity has yet commenced on the properties.

Cobra’s $35.4-million market cap reflects expectations of considerable future exploration and production success. That success is far from certain.

We don’t have confidence in Cobra Oil & Gas Company, and we don’t recommend the shares.

How the “over the counter” market works

Companies that trade on the U.S. over-the-counter market are said to trade on the “pink sheets,” a holdover from the days when the quotes for these stocks were printed on pink paper. Today, Pink Sheets LLC, a private company, is the main provider of pricing and financial information for the over-the-counter (OTC) securities markets.

Pink Sheets’ centralized information network includes services for issuers, brokers and OTC investors, as well as “market makers” (more on them below). Pink Sheets’ information aims to make OTC trading more efficient and improve access to capital for OTC issuers.

Do you have part of your portfolio that you play with? The part you're willing to be a little more aggressive with? Then let me recommend my Stock Pickers Digest newsletter. You get the stocks my proven Quick Profit/Value System ™ has identified as having the potential to give you 50% gains — or more — in 6 months or less. Click here to learn how you can get started right away.

Companies that trade on the “pink sheets” usually don’t have sufficient market caps, or enough shareholders, to meet most stock exchanges’ minimum criteria.

Over-the-counter shares are often sporadically or inactively traded. That can make buying penny stocks (and selling them) more difficult and expensive than inactively traded shares on larger stock exchanges.

As well, over-the-counter stocks trade through “market makers,” or traders who maintain an orderly market in a particular stock by standing ready to buy or sell shares. The market maker’s job is to maintain a firm bid and ask price for their assigned securities. If a broker wants to buy a stock, but there are no offers to sell it, the market maker fills the order by selling shares from their own firm’s account. If a broker wants to sell, but no one wants to buy, the market maker buys the shares.

Generally, there are a very limited number of market makers for thinly traded over-the-counter stocks. Bid and ask spreads, set by the market makers, are sometimes so wide that if you buy a stock, it may have to go up 50% or more before you’ll even begin to make money on a sale.

Over-the-counter stocks may at times seem to offer extraordinary opportunities, but this can be an expensive illusion. Most legitimate companies with substantial growth potential will want to leave the over-the-counter market as quickly as possible, and move to the major markets. This tilts the odds against you.

That’s why we’ve always stayed out of the over-the-counter market, and are likely to continue to stay out. There are just too many attractive buying opportunities in major markets where risk is lower and your chances of making money are much better.

If you have investment-related questions, or if you’d like to ask me about stocks you’re considering buying (or selling), you should join my Inner Circle service. Click here to learn more.

1. Political stability. Penny investing is risky enough without the threat of expropriation or onerous taxes.

2. Cash reserves. If pennies need to sell shares at low prices, it dilutes the interests of existing investors.

3. A strong balance sheet and good credit, or a partner to finance mine construction.

4. Top managers with successful mine-development experience.

5. Listing on an exchange with strict regulatory and reporting requirements.

6. A moderate stock price, without too much broker or investor enthusiasm.

7. A good balance between market cap and mineral-reserve expansion potential.

Our three penny buys in this issue qualify on all seven counts, but still involve high risk. So they’re buys for aggressive investors only.