Equity markets are characterised by multiple phenomena. Tug-of-war between the bulls and the bears, price movements, investors and traders and many more spices add taste to this recipe. However, all of us will certainly agree that there is one entity in this market for which all of us fall. Irrespective of our investment amount, our age, the time we have spent in the market and our risk profiles, we do follow them. Any guesses? Penny stocks!
You must have come across one of your friends talking about the killing he made just few days back when he sold 10,000 shares of IFCI at Rs 50, which he had bought at a price of Rs 8 a year ago. You must be knowing someone who had bought SAIL in 2000 at a single digit price and is still holding on to that prized possession with pride.
At the same time, you may have come across someone investing in some stock at a price of Rs 2 per share with a view that the stock will reach Rs.25 in one year. You may have also betted on any of the ‘penny stocks’. The reasons and the extent of exposure may differ but there is hardly anyone who has not been to these ‘bylanes’ of the business.
There is no definition as such for a penny stock. However, one can safely say that a penny stock is a low priced security typically available near the Rs 10 mark or somewhere near its face value for whatever reason. These stocks typically show speculative patterns and the companies have low market capitalisation. These counters may witness low liquidity and sometimes may show volumes in excess of the free float. However, more emphasis is given to the absolute low price.
Penny stocks are more a part of a punter’s paradise. There is a class of speculators that track movement in the stock prices whether backed by fundamentals or otherwise.
The smallest changes in the fundamentals of the company add fire to these counters. In Indian markets, circuit filters and compulsory delivery (T group) try to curb the fire or swift movement in such counters. However, we do come across many incidences where a T group stock is continuously hitting the upper circuit for weeks together.
This for sure creates new fans for penny stocks. Before entering into a penny stock there is a need to understand why a penny stock is available in the market.
A penny stock is the outcome of many factors. Commodity companies typically go down in the downturns. Due to the accumulated losses, the heavy burden of fixed expenses like interest and no revenues to support, their stocks trade near their face value or even at a discount of their face value. A case in point is SAIL, which was quoting at a single digit price below its face value in 2000 when the steel cycle had bottomed out. There are others that suffer from incompetent management, inefficient operations, and business cycles and subsequently shrink towards the lower end of the price towards the face value of the stock.
However, there is one more class of stock that remains perennially a penny stock. These companies suffer from dishonest and investor unfriendly management. Such companies never go down. However, they are used as a vehicle to siphon off money. Such companies’ stocks remain as duds till eternity if the management does not change.
Such perennial penny stocks are a no-no case for all investors. However, an investor with a high-risk appetite can consider them for short term trading purposes. Short term trading is not the only objective behind purchasing a penny stock. Multi-baggers can be identified in the gamut of penny stocks. If you intend to pick up a dud stock for multibagger returns then it is a task to be done with the utmost care. While picking up a penny stock with a long-term view in mind, the first factor to consider is the fundamentals of the company. A compromise on this is nothing short of driving a car without brakes. The ability to grow must be shown by the company. It must come with an inbuilt scalability.
Though small at the time of purchase, the company should be in a position to acquire size over a period of time. In addition, one should check the value-unlocking proposition of the business. Possibility of development of institutional interest in the future must be considered with due weightage, as institutional interest ensures better governance and thereby drives the valuations. The analyst community does typically not cover these stocks, there exists a dearth of information, and hence buyers must beware.
Once you take exposure to such stocks, there is a need to track them on a quarterly basis comparing their performance with the industry’s performance and your estimates. Even after a fair time span if the stocks are not delivering, you should do a reality check. This fair time span is industry specific and investor specific. In umpteen cases there is a difference between what exists and what you do see or what you intend to see. In cases, where you have gone wrong it pays to admit your mistake. You can exit such counters and park your funds in some quality stock.
A word of caution. Successful penny stock investing may appear simple but it is one of the toughest tasks like successful day trading.
At no time, should you have more than 3-5% of your entire equity portfolio in penny stocks. In the peaking bull markets, exposure to penny stocks is to be evaluated. You are the best judge of your ability to take risks and your financial goals. At the cost of repetition, when you are going after penny stocks, be pound wise and caveat emptor.
