Piggy Bank Investors are the favourite. The retail crowd especially loves them. They promise to provide huge benefits in a short span of time.
But at the same time, they are undoubtedly the riskiest types of stocks. They can crash at any time for any reason. They are notorious for destroying 90% of investors’ wealth in a matter of weeks or months.
Worse is their low liquidity in most cases. With only a limited number of shares being traded on any given day, a small increase in volume can move the stock in a big way. This is great if the stock rises but disastrous in case of a fall as most investors will not be able to sell at a good price.
Despite the risks, penny stocks are almost always popular. The only exception is during bear markets.
So in this article, we will summarize 10 important facts about Indian penny stocks.
- What is a penny stock?
Penny stocks are shares of listed companies with low market capitalization. These stocks usually have low share prices, usually less than Rs 100 and often less than Rs 50.
In the US market, these shares trade for less than a dollar i.e. pennies. Because of this name.
These stocks, in general, have poor liquidity in the market i.e. they have low trading volume. It is common to see penny stocks trading less than a thousand shares in a day.
- Potential Profits in Penny Stocks
Well-chosen fundamentally strong penny stocks have the potential to deliver more than 1,000 percent gains within 1-3 years. This is almost impossible in the case of any other stock category.
This is the main reason for his popularity. Investors are aware of these potential benefits and are looking for fundamentally strong penny stocks.
- risk in penny stocks
it is common to see Penny stocks fall 80-90 Percentage when the market enters a downtrend. Therefore, investors should be very cautious and cautious about penny stocks.
Often many retail investors think they can make a fortune in penny stocks. They invest most of their funds in one or a few penny stocks.
The result is usually a disaster. There is no shortage of stories in the stock market of people losing their lifetime savings in penny stocks.
- The Big Penny Stock Myth
There is a big myth about penny stocks in the market. You may have heard this: Penny stocks are the best way to get rich.
Even those who have not invested in the stock market must have heard this myth. A few penny stocks will do well in a bull market. Some will definitely become multibagger penny stocks.
This assures retail investors that penny stock investing is their best bet for getting rich in the stock market. What they don’t realize is that investing in penny stocks is probably the best way to destroy their portfolio.
Their original theories are questionable. Their management quality is questionable. These stocks are very sensitive to the actions of the stock market operators.
Only a few of them are worth considering as long-term investments. Most investors won’t find these needles in the haystack.
And this brings us to…
- Most Penny Stocks Are Poisonous
Penny stocks suffer from a number of issues — losses, sluggish revenue growth, high debt, low promoter holdings, high promoter mortgages — and are not considered prudent investments.
If you invest in toxic penny stocks, you are risking the security of your hard earned money.
just think about it. Would you invest in large-cap stocks if the company had a history of making losses?
I’m sure you won’t.
That’s why you should not invest in bad penny stocks either. Just because these stocks can go up a lot, it’s not reason enough. The risk-reward equation is not in your favor.
If these stocks crash, your capital will be at risk. Even worse, many penny stocks, unlike bluechips, do not recover after a crash.
- only the top 1 percent Penny Stocks Are Worth Your Money
The only penny stock worth your time and money is 1% at best. They’re the only ones that probably won’t crash 80-90% as well as have a 10x or more chance of increasing.
Here’s How to Filter Penny Stocks…
- FirstAvoid all penny stocks that have high debt. By high debt, we mean that the debt to equity ratio should be less than 1. Ideally, the ratio should be less than 0.5.
- another, the owner of the company should have a significant stake. Exclude all penny shares in which the promoter has less than 30 per cent stake. Also, pledging the shares should be a strict NO.
- third, Seek long term business viability. Penny stocks can give great returns like 50x and 100x over the long term. Its business model must be viable for this to happen. Look for companies that are likely to be at least a few years from now.
- fourth, the company must generate an income. Today it should be profitable in terms of income. If the promised profits are in the future and the companies are making losses today, stay away.
- fifthFilter by rating. They should be given deep discounts, not just cheap. It is also a good way to reduce risk. If a stock is already trading at heavily discounted valuations, then the market has already indicated some bad news.
- Checklist for Finding the Best Penny Stocks
After you’ve filtered penny stocks down to the top 1 percent, how do you shortlist the few you’d like to potentially invest in?
Well, for that you need a checklist.
Here is an evergreen penny stock selection checklist…
- strong balance sheetLook for: low debt, high cash balance, and a current ratio of more than 1 i.e. current assets to current liabilities. Equitymaster’s stock screener can help you find debt free companies,
- high promoter holding: The higher, the better. It shows that the promoter has skin in the game. Promoters buying shares from the market is a good sign. Use Equitymaster’s stock screener to find stocks where promoters are raising stake.
- quality of business: Ask this question. Is this a good business? Are the fundamentals strong? Will it happen after a few years? Is it making profit?
- cash flow: Does the business generate cash from its operations? If yes, is it increasing? How is the cash being used?
- cheap valuationIt’s always a good idea to buy when penny stocks are cheap. Check if the stock is trading below its book value. A margin of safety of at least 20 per cent below the book value is a good entry point.
- Extreme Penny Stocks
There are few penny stocks in the Indian stock market that trade below Re 1 per share. This is similar to penny stocks that trade below $1 per share in the US market.
These are the worst quality penny stocks. Most dangerous type. Such a low price of any stock means that investors have given up on it.
And there is usually a very good reason for this. It is very likely that such a stock is on the verge of bankruptcy or is in the process of liquidation. This means that its assets will be sold (assuming there is a buyer) at throwaway prices.
Any cash raised will first be used to pay off the company’s creditors. Thus, the bank will place the remainder of its share before the shareholders.
In most such cases, banks will also have to deduct ie they will not get back what they owe. Thus, the shareholders will get nothing.
- Turnaround Cases in Penny Stocks
In some cases the company manages to recover through a restructuring of the business. In other words, it manages to avoid bankruptcy as well as the following insolvency process where the shareholders are wiped out.
In such cases the shares of the company are not worth nil. Its true value will be based on the future performance of the company.
This is also a greater risk for investors but it is a smaller one that the risk of buying shares in a company on the verge of bankruptcy.
Investors putting their money in these turnaround cases are expecting the shares to be worth a lot. They are betting that the company will recover and not enter insolvency proceedings.
This is probably the highest form of risk in the stock market: all or nothing. Either you will have a huge multibagger penny stock or you will lose your entire investment.
- Getting Started with Penny Stocks
In the stock market, penny stocks belong to the category of ‘highest potential risk for highest potential return’.
While they potentially present the greatest upside potential of any group of stocks, they can destroy wealth faster than any other group.
You must accept this reality when investing in penny stocks. Even if you have a high risk profile, we recommend investing no more than 5 percent of your portfolio in penny stocks.
You can start your search with Equitymaster’s stock screener to find it best penny stocks, Screener allows you to screen stocks based on your own criteria.
Investing in penny stocks is not rocket science, but it requires extreme caution. On the other hand, if done correctly, choosing the right penny stock will significantly increase the overall return of your portfolio, especially over the long term.
This article is syndicated from equitymaster.com,
(This story has not been edited by NDTV staff and is auto-generated from a syndicated feed.)