Sep 2, 2018


So what is a penny stock? Basically broadly there are few classifications how the insiders i.e. the professionals and the outside investors understand the stocks or rather classify them. They are bluechip, midcap, smallcap, large cap and penny stocks.
Here cap mean market capitalisation i.e. the current price of stock multiplied by the outstanding number of shares or issued share capital of the company. So subsequently the higher the share price and compared to the share capital, the higher the mcap. Such companies fall into largecap or bluechip category such as Reliance Industries, Infosys etc.
So, looking at this definition of capitalisation, it does not become clear as to what exactly a penny stock means. Lay understanding of us all is that a penny stock is one whose price is in pennies i.e. in paisas or few rupees only i.e. 1 rupee or 5 rupee and so on. (Actually, pennies are subdivisions of British Pound/Currency, so here in India we should be calling such stocks paisa stocks rather than penny stocks!) So, let us clearly define that those stocks whose price is under Rs.10 should be called as penny stocks. Having cleared the doubt regarding the price, let us also understand another assumption attached with a penny stock invariably. It is that penny stocks or the companies are not at all in any favour of investors and not making any profit or into huge debt and losses for a very consistent period of time (here mark the word consistent, it need a lot of time to become a genuine penny stock as well!), which is the very reason of their stock prices being in paisas and rupees. We also understood that capitalization by which mainly the stocks are classified does not fit into penny stocks definition.

Thousands of companies' shares are listed on the stock exchanges, and over time many firms are forgotten by the analysts, brokerage and investors community, even the promoters and investors of the very firms in question forget about it! Seriously. The point is such firms may be doing very less or negligible business and there is nothing exciting going on for a very long time in the industry they operate; making these reasons for the stock price to quote as a penny stock. But suddenly, due to some re rating of whole sector or some kind of corporate development or because the firm has started to post unexpectedly positive results and is estimated to continue to do that; the stock prices starts to move up and come out of a penny stock definition to a small cap classification.
In reality, only 10% of the quote unquote so-called penny stocks makes permanently to small cap or higher classifications and come out of the tag of a penny stock. Rest of them may rise in a cyclical manner or in a bull market and then settle where they were, a penny stock. As in the example of Jayswal Neco Industries Ltd.

Many times the promoters and a group of operators are very much involved in this seasonal penny stocks price movement. They find a good opportunity, a market condition and send the price up and then bring it down again, making a good some in the process. Many stocks are only listed or kept listed for this purpose only, while the companies are not doing any business for real. So, this is clear manipulation and investors and traders both should be aware not to get trapped in any such stocks. The fact is more than 70% penny stock rises are manipulated or baseless and should be avoided by no-stoploss long term only investors.

Many penny stocks today you see were also some very big stock once, and sir legitimate businesses doing almost thousands of crores of business and making good profits. But due to some terrible blow to their sector or some company specific event or some other reason like scam etc.their business suffered and the stock tend to plummet to penny levels. The examples are Reliance Communications, once a great company, whose price was at 800 before 9 years and now trading at 10 Rs. It couldn't bear the competition and got pulled down under heavy burden of debt which is a menace to almost all firms in the sector. 
Another example is Unitech Ltd, based in Mumbai, once a premier firm in real estate sector; now trading at 7 Rs., recently Central Government has taken control of its board of directors. The firm got entangled in scandal of 2G spectrum and post-2008 world recession at the same time. The promoters are now in jail for fraud or non-delivery of flats to its buyers. The company in itself is still doing great business at almost 1000 crore annual sales and some losses. Losses are not new, most listed realty firms were in huge debt and making losses, few of which has been recently able to reduce the same, case in example, DLF Ltd. So, the point is you have to identify such, fallen heroes and see if there is any scope of improvement in their condition. This lot should be the prime watch list for investors who want to have a piece of penny stocks in their portfolio which should not be more than 15% of the total equity portfolio capital. The simple reason being that this companies still have the topline (sales), market share, strong promoters in most cases, established products or service. A turnaround is very much possible in these firms than those who doesn’t have these features and advantages. Having said that, an expert should weigh in different aspects at the particular point of time of investing in respect with the individual company before considering it a good buy as a penny stocks. Unitech Ltd is a good case in example right now whether to buy or not as the company is very well established, having great topline, good market share and so on, and was a leader in real estate pack before only few years.
Exceptions - There are exceptions in every things, so in terms of the definition and fine detailing while understanding the penny stocks.
Another type that penny stocks investors should eye are the firms who are going to be genuinely growing their businesses and making a lot of money due to one or the other reason. Now it is very difficult to identify such penny stocks because it is close to impossible to find out such thing. Yes, these stocks are more identifiable when they are small caps or midcaps but then they aren’t penny stocks of which we are discussion right now.

So what is the reason penny stocks tend to attract many investors? Penny stocks tend to attract mainly the smaller retail segment of investors. They are seldom the prey of HNI or other professional investors except in special situations or for short term trading etc. We are not saying that HNIs do not invest in them, they do invest but we are talking about the average penny stock which is mainly attraction of herd of small investors.
Main reason why investors are attracted towards these stocks is that they double their money in few days or months. Yes, they can’t do it with your bluechips like HDFCs or TCSs or midcaps like Motherson Sumi etc. The stock trading at 2 rupee has a great scope of doubling or quadrupling in 2 days or 20 days than a stock of 100 or 400 rupees. The small investors put anywhere between 5k-50k- to 100k so to multiply their money faster they take the way of penny stocks. Another important aspect related to this is the advisory tips or rumours regarding operator running the stock. Ultimately the small investor has to get the info from somewhere to identify the penny stock they want to buy. So by way of many media, the investor finds the one or more penny stock he wants to invest and then proceeds.

We are an avid investor into penny stock segment and strongly make our clients put 15% of equity capital allocation into such stocks. Our selection is out of the two types of penny stocks. One is the already explained above called as fallen heroes. The others are what we call gentleman penny stock. Gentleman penny stocks are the penny stocks not because they are seasonal stocks, firms of which are not doing much and neither want to do much, and stock prices is occasionally rigged up and down by operators with or without help of promoters; no, neither are the stocks which come into the above explained fallen heroes category. These stocks are penny because they were penny from the beginning. They are just small companies, that’s it.  These are the companies which starts growing and then called as growth stocks once they cross certain price levels and topline and bottom-line and comes in the eyes of mainstream investors and media. Our some of the past picks such as Marksons Pharma, Nila Infra fall into this category.

ü  Penny stocks should be a must in a long term investors portfolio.
ü  Penny stocks should be baught not more than 15% of the equity capital allocation.
ü  Penny stocks investing do not follow the common principles of equity investing like PE ratio, growth rates, profit making company, and so on.
ü  Investment into penny stocks should be made for with clear time frame and target in mind. They seldom qualify for long term or permanent holdings.
ü  More than one penny stocks should be baught.
ü  Atleast 5-10 times and more return should be expected in such investments.
ü  You can not put stoploss in such investments.
ü  With sound research one can identify good penny stocks which can grow into small cap and midcap stocks of tomorrow.
ü  Many times at recessionary conditions and due to other issues, many stocks of marke business groups trade at sub 20-10 levels. They should be identified as they rise faster and higher already having many plus points to their credit.
ü  Avoid seasonal names like Jayaswal Neko, Karuturi global, Pochiraju etc. which rise and fall all the time and are pure breed penny stocks.(unless ofcourse you are a professional penny stocks trader)
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