As it happens in every bull run, retail investors, who have missed out, are now trying to figure out ways to make up for lost time. It is at this time, that they start evaluating the prospects of penny stocks — shares that trade below Rs 10. If you are among those who would like to bet on these stocks, here are some pointers.
CHECK THE FUNDAMENTALS AND VALUATIONS
Lack of information and the penny tag are the two sides of the same coin. These companies being small and difficult to access, there is lack of information about them in the public domain. There is little or no research coverage from prominent brokerage houses on such stocks. To be specific, you need to verify the credentials of the promoters and, more importantly, to ascertain the plausibility of the 'story' sold to you. If you have come across 'turnaround' stories and 'new technology' advances by companies, check with the experts in those industries. If you cannot put in efforts to that effect, just steer clear from such opportunities.
If a stock with a face value of Re 1 quotes at Rs 5, it is as good as a stock of Rs 50 with a face value of Rs 10. Hence, do check the face value and the valuation the stock enjoys. There are stocks that quote at Rs 10 or 12 when the face value is Re 1 and there is no business model in place, forget profits. Better to let go stocks with skyhigh valuations, unless you have compelling reasons to go for them. Only if you are sure about the credibility of the management and the fundamentals of the company should you invest in such stocks.
HOW CHEAP IS CHEAP
If one compares the valuations of penny stocks with those of industry leaders, the tag cheap is obvious. But one must remember that penny stocks could become even cheaper as there is little or no earnings and no track record to back the valuations they enjoy. No wonder some of the penny stocks become cheaper at a rapid rate when markets cool down. Be cautious when the stocks fall; do not attempt to catch a falling knife. All lasting downtrends start with a correction. Owing to poor liquidity, the stocks may have unidirectional movements. But if an investor fails to recognise the peaking point, there is a likelihood of getting stuck with the stock, as buyers vanish once the stock price slides.
Questionable investments are made by 'experts' with a view to selling them to a less-informed investor — a bigger fool. If you are not convinced with the story you are buying, ensure that there are many more bigger fools around. Those who fail to identify one, end up with loss of capital.
THE ATTRACTION OF SMALL
Many forget the real world where stock prices double as the earnings double. There is no way low-priced stocks can double faster than the largecap stocks fundamentally. You should also note that when a Rs 5 stock stops trading on bourses after coming down to Rs 2, it is not a loss of Rs 3, but even worse: it is loss of capital.
At some point, when markets have risen to a level where further gains look unlikely and there is not much left on the table, it may not be a great idea to experiment with penny tips. "If you are one of those who have made money in the bull run, don't risk the profits with penny stocks. If you have not made money in the bull run, wait for a correction in large-cap counters," says a Mumbai-based fund manager.
WORTH EVERY PENNY
Rule book for penny stock investing
q THE PENNY stock portfolio should not be more than 5-10% of the entire equity portfolio
q PUT YOUR money on penny stocks only after a thorough research. Tips in most cases, lead to traps, resulting in permanent capital losses
q THERE IS little or no research coverage from prominent brokerage houses on such stocks NEVER PUT the entire sum at one go, take a systematic exposure in tranches
q PENNY STOCKS could become cheaper as there is little or no earnings and no track record to back the valuations they enjoy
q THE MOST important activity is tracking your investments. Do not expect any help here. Better do it with rigour
q THERE IS no way low-priced stocks can double faster than large-cap stocks fundamentally
q DO NOT hesitate to book losses
q IF YOU fail to recognise the peaking point, there is a likelihood of getting stuck with the stock, as buyers vanish once the stock price slides
q DO NOT bet on one stock. Instead, maintain a bouquet of a large number of penny stocks, given the high possibility of going wrong on stock selection
