The Perils of Investing In Penny Stocks

A stock that trades at a relatively low price is termed as penny stock. The term is a misnomer in itself as there are various definitions available for the stock. The term originated in the US and was used for stocks with price below $5.

PENNY STOCKS

The stocks are generally known to be highly speculative in nature, carrying large bid spreads, limited following & disclosure and relatively small capitalization in the market.

A penny stock generally trades at a very low price that is usually below Rs 10 on the exchanges.

Exchanges usually put these stocks in the category of trade-to-trade (T2T) but some also include them in the B group on BSE.

Concerns for Investors

For the reason these shares are thinly traded on the exchanges they can easily become target of manipulators.

A small amount of investment is more than enough in triggering a spike with them.

For instance, you can easily increase the price of a penny stock that is standing at a rate of Rs 2 presently to Rs 4 with minimum of efforts. This is almost a 100% rise and can attract a large number of investors especially when the markets are facing bearish sentiment.

How do Manipulators bring about such a change?

This is usually achieved by spreading positive news about the stock in the market making the stock rise.

Once the price rises to certain levels, small investors make a beeline to invest in the share. This is when manipulators sell the stock triggering a major crash which leaves small investors in a lurch.

Gains from penny stocks

Penny stocks can act multi-baggers in no time and can rise from Rs 2 to Rs 20 in less than a year. Otherwise, blue-chip companies such as TCS may take years to give a 10 achieve a ten times rise.

For the reason there is little information about their promoters or the company, the risk return ratio is very high with them.

Some of the examples with penny stocks are Globus Corporation Ltd. And Flawless Diamonds which are trading below Rs 1 presently.

Before investing in such stocks you must consider the following points:

  1. Why these stocks became penny?
  2. The information about the fundamentals of company.
  3. Information about its promoters and corporate governance history.
  4. Proportion of promoter stake. A high promoter’s stake is what you should look for.
  5. Sales record and institutional shareholding. Better to have high sales record and institutional sharing.
  6. Should not have high number of subsidiaries. More subsidiaries may lead to corporate governance issues.

You should study company’s fundamentals in detail. If you think a stock is good but is undervalued due to reasons beyond its control, you can invest in to it.

Ashish Pandey

I am a business journalist who is currently employed at Zee Business. My areas of interest include business and foreign policy. You can reach me on Twitter at @ashuvirgo1984 or @eFundsPlus.

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