What are Penny Stocks ? Features & Investment Options

What Exactly Are Penny Stocks? 

Penny stocks are equities that have a very low market capitalization and trade at a very cheap price. 

In India, penny stocks typically trade between Rs 0.05 and Rs 10 per share. 

These are ultra-micro-cap firms with a market valuation of less than Rs. 50 crore.

The Benefits of Investing in Penny Stocks:

Penny stocks are typically unknown to the broader investing public. Regular investors avoid such companies because they are concerned that the fundamentals are unknown. Because of the low market capitalization, institutional investors avoid such stocks as well. 

However, here is where an investor who is willing to perform adequate research into the fundamentals of the penny stock has an advantage. 

If the investor can locate a penny stock with strong fundamentals and purchase it at incredibly cheap values, he can earn a fortune.

Risks and Drawbacks: 

The first danger of investing in penny stocks is that their fundamentals aren’t all that great. The investor does not have access to appropriate research papers. Even the veracity of audited financial statements might be put into doubt. 

The second danger is that the volume of shares exchanged is exceedingly low. This makes them an obvious target for unscrupulous operators looking to manipulate the stock price by cornering a large number and sending the price skyrocketing or dumping a huge quantity and sending the price plummeting.

Stock exchange limitations pose a risk: 

Because these are often very tiny businesses, their adherence to the law and stock market requirements may be lax. This may result in adverse regulatory action from stock exchanges, which may result in the scrip’s suspension from trade. 

Another danger is that the Stock Exchanges (BSE and NSE) impose upper and lower circuits on businesses in order to discourage excessive speculating in them. 

The installation of a UC or LC on the stock may impair the trader’s ability to leave the stock when he desires.

SEBI has delisted a lot of  penny stocks : 

SEBI has issued an order directing that almost 2000 firms, including a number of penny stocks, be delisted from the BSE and NSE for failing to meet the stock exchange’s and SEBI’s standards.

Multibagger penny stocks that have made investors wealthy include: 

If investors are fortunate enough to locate the right stock, these stocks may become multibaggers, allowing them to amass tremendous riches. 

Gayatri Sugars, netvista Ventures Ltd, KM Sugar Mills Ltd, Sybly Industries Ltd, and other penny stocks have provided more than 300 stocks. 

Up to 33 penny stocks have provided returns ranging from 100% to 300%.

Penny Stock Investing Guidelines: 

Investors who want to invest in such companies should keep the following guidelines in mind. These guidelines will ensure that the investment is not negatively impacted even in the worst-case scenario:

1.  Invest just little sums:

Ensure that just a modest portion of the portfolio is invested in such stocks, no more than 10% of the portfolio. 

2. Diversify broadly and maintain a portfolio of penny stocks: 

It is usually prudent to handle penny stocks as a group and spread your investment and risk over four or five stocks. 

The disadvantage of this technique is that even if one or two of the stocks become huge winners, the impact on the portfolio will be mitigated by the other stocks in the portfolio.

3. Regularly monitor the performance: 

Penny stocks are not buy-and-hold investments. They must be closely monitored due to their very nature. The investor must be prepared to sell his equities at the first indication of difficulty with the fundamentals.

4. Be wary of study findings that present a bright picture: 

Penny stocks are a favourite haunt of traders and manipulators. They aim to entice inexperienced investors by painting an exaggerated and rosy picture of the stock. Then, when the gullible investors have purchased the stock, the operators sell it, leaving the investor high and dry. 

5. Maintain a strict loss: 

Unlike equities with solid fundamentals, where a weakness or fall in stock prices allows investors to average the stock price, penny stocks should have a rigorous stop loss in place. A drop in the stock price is generally an indication that the stock’s fundamentals are worsening. Attempting to average such equities might result in further losses for the investor.

How To Verify Undervaluation of Stock?

We may use three financial ratios to determine whether or not the present stock price is cheap. 

• The price-to-earnings ratio is referred to as the P/E ratio. This method may be used to determine the P/E ratio ( =Price / EPS). It is simple to calculate the P/E ratio. However, I have a better suggestion here. Plot a curve based on the previous five years’ P/E ratio. How should it be done? First, set up this table. Examine the PE trend over the previous five years. How should it be done? By drawing a curve. If the P/E ratio falls, it indicates that the stock is undervalued, and vice versa.

• PEG ratio: This is a statistic that compares the price of a stock to its anticipated future growth rate. This method may be used to determine the P/E ratio ( =PE / EPS growth rate). PEG is a highly helpful financial statistic for assessing a stock’s price value. A PEG less than one indicates that the stock is cheap. A stock with a high PE but a low PEG (1) is desirable. A stock with a low PE but a high PEG (>1) is not a smart investment.

• Dividend Yield (DY): The ratio of dividend per share to price. This method may be used to determine the DY ratio (= Dividend per share / price). Dividend yield is an excellent “value indicator.” Why? Because a stock that passes this criteria will almost certainly be undervalued. How should this analysis be carried out? We shall once again depend on a 5-year trend rather than one-year data. Plot a curve based on the previous five years’ dividend yield. A rising dividend yield indicates that the share price is becoming undervalued.

Conclusion:

I just read an article on “penny stocks for long-term investors.” The author was vehemently opposed to penny stocks. Probably, he was just interested in penny stocks as a “trading alternative.” 

However, penny stocks can be a wonderful long-term investment for me. Why? Because the growth potential of a good penny stock much outweighs that of a large cap firm. 

So, how can you get started investing in penny stocks? I discussed my penny stock filters in the last article, but there is something more I’d like to highlight here.

There is a distinction between large and small cap stocks. Large cap stocks have a well-established track record. However, small cap penny stocks have not been subjected to the same level of scrutiny. 

As a result, I employ this technique when dealing with penny stocks. Every six months, I utilise my criteria to identify two-thirds of the penny stocks. But I don’t go out and buy them right away. 

I put them on my watch list and keep an eye on them for at least a month. During this period, I strive to learn everything I can about them. I use “Google Alerts” to receive updates in my inbox about them. 

I buy them once I’m feeling more secure with them.