In 2006, small cap stocks out performed large cap stocks, and are poised to perform well again this year. History shows that, over time, the best performing stocks started small. Just remember... correlation is not causation.

For example, in Los Angeles, ice cream sales increase when the pavement cracks. Does this mean that cracking pavement influences ice cream sales? Nope. It means that the hot summer sun wreaks havoc on roads. Hot weather also makes kids buy ice cream.

Or put a different way, penny stocks are expected to perform well in 2007, but just because it's a penny stock does not make it a winner. There are other important factors at play.

At the outset, penny stocks look attractive because they are trading at, what appears to be, bargain (read 'cheap') prices. Buy a stock at $0.10; it pops two cents and you're looking at a 20% return.

Unfortunately, picking winners is not as easy as it seems. Over the long run, penny stocks earn their investment returns the same way other stocks do - based on their performance.

Sure penny stocks can pop on a single press release, but in the end, the share price is still rooted in fundamentals.

The fascination with penny stocks obviously has to do with the idea that they are considered to be "cheap" or "inexpensive". And nothing could be further from the truth.

First off, let's get rid of the word "cheap". There's no such thing. I tend to look at all stocks as being either ‘costly' or ‘expensive'. What's the difference? Let's say you collect antiques. You walk into a store and end up paying $5.00 for something that's really worth $2.50; that's expensive. If you walk into a store and pay $1000.00 for something worth $1000.00, that's costly.

Do your due diligence. Run your prospective penny stock picks through your own tested stock filter. Buying a penny stock at $0.10 may seem like a bargain, but it could be an expensive error.

Fundamentals aside, are there other ‘secrets' to finding superior stocks? One article I read discovered that the best-performing small caps all shared one very telling trait: a dedicated management team.

Roughly 84% of the 100 best-performing small caps from 1996 through 2005 had a management team that either owned more than 5% of the company's shares or had been at the helm at least 10 years.

That fact was true of fewer than 50% of small cap stocks overall.

A dedicated management team is crucial to the success of your penny stock. Think back to some of today's Wall Street juggernauts. Microsoft and Dell were both led by a founder, who owned shares of his company and was committed to building the best business possible.

It's not the be-all of penny stock research, but knowing that the management team of a prospective stock is well seasoned AND has a vested interest in the company speaks volumes. And is a good place to start.

It may not be the best way to spend an hour of your life, but it's also a good idea to listen in whenever your prospective company hosts a conference call. With penny stocks, this most often occurs immediately following a quarterly press release.

Listen closely to how management talks about the business and fields questions. And if you're still not convinced, put in a call to investor relations. Or better yet, unlike the blue chip behemoths, prospective penny stock investors can usually get the CEO on the phone.

You two may not end up being close friends, but field the right questions and you could get an edge over the throngs of less motivated investors.

The allure of penny stocks is undeniable; and so too are the risks. But penny stocks need not be any riskier than their larger peers.

Delve into your penny stock of choice and figure out if it's expensive, or costly. Cover your bases and you may very well uncover the small number of penny stock wonders currently trading under Wall Street's radar.