So take a look at the following example. You have $10,000 dollars you want to invest and you are thinking about 2 different options. The first one is a secure government bond that is offering you a guaranteed 5% return on your investment. The second is a company that will also pay you a 5% return on your investment but only if the company makes a return, which it has successfully achieved over the past few years.
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Therefore which option would you choose to go with? Well hopefully as a smart investor you would decide on the first option! The first option is virtually risk free and offers the same return on your money as the second option but thiswill only pay if the company makes a profit and a proven success record is great but it does not depict future performance.
But if think about if the second option was going to pay you a 15% return on your money instead of 5% then some people would take the risk and opt for the higher gain. Your own risk profile would determine which option you would choose
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The above example just illustrates why penny shares are so popular as an investment vehicle and the returns can be much higher than 15%! You can work out what you think the intrinsic value of the company is worth by examining the fundamentals of the company but the returns you earn from penny stocks is dictated to you by the external market forces which cause a stock to rise and fall..
When analyzing different companies you want to look at the P/E ratio (price to earnings ratio) and to work this out you divide the current stock price by the return it will give you.A small cap stock that is just starting out will have a much lower P/E ratio than amore established stock that has a proven track record. Therefore the lower the P/E ratio then the higher the associated risks with investing in that company.