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updated on 1 may 2017
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Should you invest in penny stocks or choose other stocks
Penny stocks are those that trade at a price below Rs 10 a share.
On April 24, over 1,800 stocks on BSE were trading below Rs 10, including the likes of VKS Projects, Silicon Valley, KSS Ltd, Avon Corporation, MPS Infotecnics, Birla Pacific, REI Six Ten, Vertex Spinning, Deccan Polypacks and Jupiter Industries, among others.
There do exist the odd gems among them and they do deliver big gains. Among top gainers in the penny segment, Cybermate Info multiplied investor wealth nearly seven-fold in the past three years, surging from Rs 0.52 on April 25, 2014 to Rs 3.54 on April 24, 2017. Others like Gennex Lab (up 564 per cent), Noble Explochem (up 479 per cent), Gayatri Sugars (up 462 per cent), Alps Industries (up 376 per cent) also gave handsome returns to investors in the same period. But it requires plenty of luck besides everything else that can help push a stock higher.
The study by ICICIDirect showed there is only a 42 per cent chance that an investment in penny stocks will yield returns, that too if you can hold it for at least three years. In contrast, 86 per cent of stocks priced above Rs 1,000 made money for investors in the past three years.
Small investors tend to believe a stock trading at Rs 3, say, runs a higher chance of becoming Rs 30, while one quoting at Rs 300 will find it harder to become Rs 3,000. Usually, stock prices rise based on fundamental factors such as good management, financial performance and have no links to from what level it starts rising.
There are also instances in the listed universe when a largecap stock would have tanked because of certain headwinds or temporary financial difficulty and become a penny stock. For instance, UnitechBSE -0.88 % which was hovering above Rs 500 in 2008 now trades at Rs 5. Rising debt and a cash crunch majorly impacted the stock price.
One must look at a company’s business model and promoters’ credential besides source of revenue, Ebitda, debt-to-equity ratio, earnings per share (EPS) and price multiples before picking a stock. These can largely indicate the state of health of a business and, thus, the potential in a stock.