DEFINING PENNY STOCKS - EVERYTHING AN INVESTOR WANT TO KNOW AND SHOULD KNOW ABOUT PENNY STOCKS INVESTING
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.
GENUINE PENNY STOCKS RISE -
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.
MANIPULATIONS AROUND THE PENNY STOCKS -
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.
FALLEN HEROES, PRIME PREFERENCE FOR PENNY STOCK SELECTION -
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.
THE
ATTRACTION OF PENNY STOCKS –
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.
OUR
APPROACH –
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.
EPITOME –
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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