Don’t let temperamental returns sway your decision

To be sure, the company’s share price recently came in after several quarters of losses, turning highly profitable in the December quarter in FY22.

Penny stocks seem to be quite popular among many retail investors, as some of them have delivered huge returns. Of all the penny stocks listed on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE), 448 stocks have disclosed their latest shareholding, with retail investors holding 20% ​​or more in about 40% of them.

The lure of making huge profits fast with minimal investment attracts retail investors to these penny stocks.

For the same amount, they can buy as many shares in a penny stock as a bluechip company. For example, an investor gets 39 shares of Reliance Industries on an investment of 1 Lac. For the same amount, the investor will get 25,000 shares in Vikas Ecotech, which is a penny stock 3.85.

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Because of their low base, a small gain in the stock prices of such shares equals a large gain in percentage terms. But do the rewards outweigh the risks of these penny stocks?

miss more than hit

An analysis of the performance of penny stocks over the past five years shows that retail investors had high shareholdings (20% or more) as of the September quarter 2017, indicating that a little over a third of such stocks held Nifty 50 index returns. close to or greater than that given. Over the past five years (see: graphic).

What is more worrying, however, is that a substantial portion of such shares – 42% – were suspended or delisted from exchanges. The suspension was either due to infringement, or due to default in annual listing fee or restricted trading as these shares were kept under surveillance by the stock exchanges. Some of these were simply removed from exchanges after being suspended for long periods. One-fourth of these paisa is well behind the 71% return (in absolute terms) seen by the Nifty 50 index in the last five years.

penny stocks for a reason

To be sure, there were many penny stocks that delivered multi-bagger returns (over 100%) over the past five years, but that was still just a third of the 456 penny stock universe.

Hemang Jani, Head-Equity Strategy, Broking & Distribution, Motilal Oswal Financial Services (MOFSL) says, “If investors look at penny stocks based on stock tips on any social media platform or market rumours, they can expect to see the potential. There is nothing to reduce. of losing your capital in such penny stocks.”

“If they still want to take their chances, it’s important that they do some due diligence to find out what factors could lead to a stock re-rating or the company’s turnaround, ” They said. adds up.

Many penny stocks today are available at such low stock prices because of deteriorating business fundamentals. This could be due to a huge pile of debt, disruption caused by competition or new player entry, or a drop out of use of the product or service.

Take the case of Vodafone Idea, whose shares are only . trades on 8.58. Apart from the huge debt, the stock has been beaten by the competitive intensity in the telecom industry after Jio’s entry. Retail investors hold around 6% stake in Vodafone Idea.

Deepak Jasani, Head-Retail Research, HDFC Securities, says that many penny stocks have lost their value in bad times. “Investors think that the prices are so cheap, such stocks are unlikely to see further correction and hence there is a margin of safety. But this is not a correct understanding of the margin of safety.”

Promoter eligibility and corporate governance standards in some penny stocks are also things to look at. Some of these stocks are easy to manipulate due to their low volumes. Therefore, by creating artificial volume, a sudden jump in the price of some penny shares can be observed, allowing some set of investors or promoters to exit.

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Not for small investors

The high risk in penny stocks does not make them suitable for small investors. If the investor makes a wrong bet, he may see a sharp capital erosion and the lack of liquidity may also not allow the investor to exit his position to cut losses. Penny stocks are not showing much volume on the exchanges.

Jani of MOFSL says penny stocks are not for small investors. “A high net worth investor (HNI) can take a risk with a small portion of his portfolio and still bet meaningfully on a penny stock. However, a small investor may risk a substantial portion of his or her net worth when a penny is put on a stock. Therefore, he stands to lose a lot on such investments,” he says.

beyond stock prices

A cheap stock does not necessarily mean an attractive stock. Affordable valuations should be viewed as a catalyst for the company’s future prospects, turnaround and management quality. Its balance-sheet may be weak due to high debt or high inventory, but are there signs that management is working to improve it or is looking to venture into new businesses to revive the company? If not, the penny stock is likely to remain the same.

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