Penny stocks surge up to 4,300%, even with ZERO sales, thanks to retail investor frenzy

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August 27, 2020 10:28 AM

Retail investors’ frenzy over small stocks in India has reached such extremes that shares of some companies that aren’t booking any sales, let alone profits, are going through the roof.

The prospect of risky investments turning sour raises concerns that any sudden withdrawals by small traders could wind up hurting the broader market as well.

Retail investors’ frenzy over small stocks in India has reached such extremes that shares of some companies that aren’t booking any sales, let alone profits, are going through the roof. These include Transglobe Foods Ltd., a fruit-jam maker that has skyrocketed more than 4,300% this year, and real-estate services firm Shree Precoated Steels Ltd., which has jumped over 1,300%. Both companies booked losses on no sales in the latest fiscal year.

The prospect of risky investments turning sour raises concerns that any sudden withdrawals by small traders could wind up hurting the broader market as well. That’s due to the rapid expansion in the presence of individual investors in India’s stock market, mirroring record sign-ups seen at U.S. brokerages including Robinhood during virus-related lockdowns.

“The outperformance of retail-driven small stocks raises the risk of a pullback and some contagion” to broader markets, said Sumeet Rohra, a fund manager at Smartsun Capital Pte. in Singapore. Investors should stick with “quality stocks which have not participated, rather than chasing small caps,” he said.

While stocks of all sizes have roared back from the depths of the pandemic selloff, the recovery in smaller Indian shares has been stronger. The S&P BSE Small Cap Index has surged 69% from its March low and is now up 9.3% for the year. In comparison, the benchmark Sensex has climbed about 50% from its low and is still down 5.3% in 2020.

The small cap rally has been aided by the influx of amateur traders, with about 2.8 million new retail accounts opened since March, according to data from Central Depository Services (India) Ltd. The flood of individuals, many with limited knowledge of fundamental and valuation metrics, is making some pros reconsider their positions.

“It is time to book some profits, as retail money is chasing penny stocks like crazy,” said Chokkalingam G, chief investment officer at Equinomics Research & Advisory Ltd. in Mumbai. “People are buying anything without knowing its price-to-earnings ratio or Ebitda or earnings,” said Chokkalingam, who estimates that individual investors now account for about half of total trading in Indian equities versus about a third last year.

India’s overall equity market value has increased by nearly $770 billion from the March low, according to data compiled by Bloomberg. This hasn’t been all due to local individuals — India is one of the few Asian markets where foreigners are net buyers in 2020.

It’s also true that some broadening of the rally is welcome given concerns not long ago that gains were being dominated by just a few big names. Technicals are supportive, with the Sensex keeping below overbought levels, but some still see a need for caution.

True Beacon, a top-performing Indian hedge fund, told Bloomberg last week that it has trimmed bullish bets as the market has run ahead of fundamentals. It encouraged retail investors to stick with blue-chip companies.

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