Penny Stocks in India
One of the most consistent mistakes a significant number of inexperienced investors make is to be drawn to a type of common stock known as penny stocks. At first glance, the reasons for this (ultimately dangerous) appeal are legion but almost always come down to the fact that penny stocks appear to fluctuate tremendously in price, which appears to lead to an opportunity to generate a very high return quickly.
Unfortunately, as with all investments, appearances are quite deceiving. It often turns out to be precisely the opposite of a high return as penny stocks can wipe out your savings in the blink of an eye.
There is no theoretical definition for penny stocks in India. However, stocks that trade at single-digit prices with low market capitalisations are bracketed in this club. Some typical characteristics of these stocks tend to be low promoter holding, huge debt, accumulated losses, and poor dividend track record. However, stocks like Vodafone Idea and Suzlon Energy, which now trade at prices of less than Rs 10 with huge equity base and market capitalisation of nearly Rs 26,000 crore and Rs 3,232 crore, respectively, do not fall in this basket.
They are a form of market traded security that attracts minimal pricing. These securities are mostly offered by companies with lower market capitalisation rates. Therefore, these are also called nano-cap stocks, micro-cap stocks, and small-cap stocks, depending on the company’s market capitalisation.
A company’s market capitalisation rate is determined based on the product of the current price of its shares or stocks and the number of outstanding shares i.e. NAV of shares x number of outstanding stocks.
Based on this factor, companies are indexed in recognised stock exchanges such as the National Stock Exchange and Bombay Stock Exchange. Penny stock lists are often found in the lower sections of such stock exchanges or lesser-known stock exchanges.
Penny stocks in India are released by companies with market capitalisation lower than Rs. 5,000 Crore.
These are the small capital company stocks that have a very low price attached to them. This makes investors believe that they are buying some real cheap equities. Many investors, especially the less experienced ones, find the penny stocks attractive because of their low price. Several novice stock market investors tend to prefer buying 10,000 shares of a penny stock (priced at 1 rupee) instead of a stable company stock that is priced at INR 1000 or more.
The thought process for them goes like this: With an investment amount of INR 10,000, one can purchase as many as 10,000 shares of the 1 rupee penny stock. On the other hand, one can purchase only 10 shares of the stable company stock with a market price of INR 1000. Such beginners to the stock markets fail to understand the difference between price and value. Just because you can buy more shares of a company doesn’t mean that you will earn more profits.
Given the scale at which the companies offering such stocks operate, they are prone to huge risks. These stocks heavily rely on the market conditions for growth in their value.
In general, a rise in stock prices tends to be backed by fundamental factors like good management, better financial performance, and business expansion. That's not the case in this space. Investors should be careful not to get trapped into buying low-valued shares since that can degrade the quality of investments. Market experts advise conservative investors to avoid penny stocks. Sometimes such stocks are driven by market operators. When they fall, these stocks at times tend to hit lower price circuits continuously, making it impossible for small investors to exit their positions.
From large ask/bid spreads (the difference in selling price and buying price) to illiquidity that can make it difficult to enter or exit a position, penny stocks are fraught with dangers that even the most experienced investors avoid. You must understand some of the biggest risks, should you be looking to venture into penny stock investing.
At the very least you should work to understand that buying these securities has more in common with playing slot machines in Las Vegas than it does a disciplined investment program. On average, you are more likely to lose significant amounts of money than you are to make any.
Apart from the basic perils which come with any market-linked securities, there are other forms of risks associated with penny stocks. These are –
Limited information:
Given the fact that companies issuing penny stocks are start-ups, there exists a dearth of information on their financial soundness, past performance, growth prospects, etc. Individuals might end up investing in them half-wittingly. Therefore, conduct thorough research into the list of penny stocks in India before investing.
Scams:
Penny stock scams are commonplace in international financial history. One such popular method is “Pump and Dump”. Companies and scammers purchase a considerable amount of penny stocks resulting in value inflation which attracts other investors to follow the hype.
High Risk:
Higher the Risk, Higher the Reward. This is a common notion passed around in the stock market. In the case of the risky penny stocks, the probability of getting the rewards will be too less. Maybe 1 out of 10 penny stocks could give you rewards.
There have been cases where people have waited for more price rise in penny stocks, and then got stuck because the price started falling continuously after reaching a certain high level. This is because it is not possible for any investor to judge the appropriate levels of exit from a penny stock, even when it turns profitable. Plus, there is no guarantee that a penny stock would remain profitable in the long run. There have been numerous examples of penny stocks that were profitable for investors at one point in time, but are now lurking around price levels below their purchase price. Before you even know it, many of the penny stock companies may turn bankrupt.
Manipulative Nature:
Because of the low market capitalization of penny stock companies, it is extremely easy for any trader to manipulate the price of penny stocks. Someone can simply buy a huge quantity of these shares with an investment amount of 1-2 crores and cause the stock price to rise. This tends to create an illusion of heavy demand and amateur investors start pumping money in without knowing the facts. This allows the initial manipulator to exit the stock with heavy profits, leaving other investors stuck with the penny stock. Some of these instances have even been reported by SEBI.
These shares are less likely to attract trades on the exchanges, hence can easily become a target of manipulators. Even a small buying in these scrips can boost the market price of these shares to unimaginable highs for no ostensible reason. It is very easy to effect a change in these types of shares as they trade at very cheap prices.
For example, a share with a market price of Re 1 can go to Rs 3 in no time, if even a small investment is done. A rise of 200 per cent would attract other investors to put their money to make a quick buck. However, these are the traps to manipulate and wash out the money invested by others. As a manipulator would sell at a hovering high price leaving all others at huge losses.
Low Liquidity:
In the case of penny stocks, the number of shares available may appear to be quite high. In reality, the quantity is limited. You can also expect considerable price movements in terms of percentage. For example, a stock priced at 50 paise can easily by 5-10 paise in a day making it a 10-20% rally. Due to possibilities of such volatile price movement in any kind of stocks, exchanges generally limit how much a stock can rise or fall in a single day. The same holds true for penny stocks, on which there is a 5-10% limit beyond which price cannot rise or fall in a day for a particular stock.
You are likely to face difficulty in buying such penny stocks. Due to non-availability of shares in the market, there may be no sellers at times when there is a huge demand. A similar difficulty could arise when you try to sell the stock. There may be no buyers or the share price has reached its lower limit for the day. In penny stocks that deliver bad results or have some bad news floating around, it is normal for investors to wait for several days or even weeks before they could sell off the stock. But by then the price falls so much that it results in a huge loss.
These are the small companies which attract zero or low trade volumes. Even if an investor sets a bid for sell or buy, it takes time to settle due to low volumes. This is why penny stocks are illiquid, as they would not sell when required.
Lack of Consistency in Performance:
Many investors go for penny stock companies, hoping that they would turnaround their business sooner or later, and become blue-chip of tomorrow. However, the turnaround for such companies is very difficult. Good performance in 2-3 quarterly results doesn’t make a turnaround case. For a real turnaround scenario, a small-cap company has to have a series of good annual results, after which the investors can start benefiting from a long-term perspective. Such turnarounds are very rare. Most of the times, such companies fade away after giving a couple of good quarterly results, leaving investors with nothing but hope and a junk stock.
However, once enough buyers have invested in such stocks, such companies and scammers dump their shares. This results in an immediate lowering of value followed by losses on the scrupulous investors’ end as they try to sell it.
When you are browsing through the list of penny stocks in India, ensure to conduct thorough research on the respective companies. Gather information on their financial soundness, stability, growth prospects and any track record on their operations.
Companies with integrity and potential will offer the customers enough knowledge of the mentioned factors to make informed decisions.
What are the Alternative Options to Penny Stocks in India?
You can make use of the Best Bank Nifty Option tips or Day trading tips given by Top SEBI Registered investment advisory services and start with authenticated information.
Individuals can also decide to invest in other investment options that are better suited to their objectives and risk appetite. Mutual Funds are one such option that is increasingly gaining popularity in the market. MFs are investment pools that involve multiple individuals investing in a single fund which is then used to purchase securities.
A few Mutual Funds investment options are listed below –
Large and mid-cap equity funds: This kind of MFs is employed to purchase equity shares and stocks from large-cap and mid-cap enterprises. These funds have moderate return capacity and entail lower risk compared to penny stocks.
Debt Funds: These funds are used to purchase fixed income securities and come with a lower risk factor. However, the return potential on such funds is limited to 12%.
Hybrid Funds: These funds are employed to purchase a mixture of market-linked and fixed income securities. Depending on the constitution, the risk and return factor varies. Hybrid Funds are a great option to diversify your investment portfolio and balance the reward and peril elements of it.
These funds comprise of a massive volume of securities available in the market including large-cap stocks, mid-cap stocks, small-cap stocks, treasury bills, government bonds, debentures, etc. apart from penny stocks.
Remember to conduct diligence before selecting the right investment option according to your financial objectives. Research before the investment is very important. An investor should analyse all the parameters like fundamentals, technical, financial numbers, news, management details, etc. However, these are the micro capital limited companies with small businesses. The information available for investors can be manipulated or hidden. Therefore investing in these shares can be a risky option as there is no scope of research.
The reality of the situation is that there is no intelligent reason an investor needs to trade penny stocks or hold them in any type of portfolio. The risks are simply too great to offset any perceived benefits. While it may seem boring, a diversified, low-cost index fund is a superior choice for many new investors.
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