What are penny stocks & how to go about investing in them?

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Every so often penny stocks grab the spotlight. There is no dearth of media reports highlighting lesser-known companies with tiny market capitalisations that became multi-bagger stocks. But you will also come across coverage reports that don’t portray penny stocks in a positive light.

If you too are looking to invest in multi-bagger penny stocks or are searching for cheap stocks that might become multi-baggers, this article is for you.

What are penny stocks?

A stock available for less than a US Dollar is a penny stock. But that’s a classical definition. Conceptually, penny stocks are tiny, low-priced, under-research, lesser-known companies. In terms of market capitalisation profile; any company with a market cap of less than 0.001% of the total market cap of companies listed in India, is a penny stock.

How does the market cap distribution look?

At the time of writing this piece, the total market cap of companies listed in India is Rs 284 trillion or Rs 284 lakh crore. Amongst the 1,727 listed companies which are actively traded, the first 1,000 companies account for 98.7% of the total market capitalisation. In other words, the bottom 727 companies collectively represented a tiny market cap of just 1.3%. Of these, close to 155 stocks have a market cap of less than 0.001% of India’s total market cap. These can be considered pure penny stocks.

Who should invest in penny stocks?

Only those investors who completely understand the risks involved in penny stocks.

Novice investors should stay away from penny stocks and concentrate only on front liners. And even the most experienced investors can attain optimum diversification by focusing on the first 500 companies.

How much should I invest in a penny stock if I am ready to take the risk?

An amount you can easily forget, FOREVER; especially when you are investing in penny stocks under Rs 1.

What are the characteristics of a ‘typical penny stock’?

  • Tiny market cap
  • Shaky fundamentals
  • Poor compliance record
  • Sudden, sharp and speculative stock price movements (without any visible change in fundamentals)
  • Lack of institutional participation
  • Retail dominance
  • Low promoter holding

What is the biggest risk associated with penny stocks?

Penny stocks with lower promoter holdings are easy to manipulate.  For instance, with Rs 5 crore, a speculator can grab a 5% stake in a company with a market cap of Rs 100 crore. In the absence of liquidity, a sudden demand for shares tend to propel stock prices and surging prices attract retail investors looking to make a quick buck.

Research thoroughly before investing: The proliferation of unchecked and easily accessible online content can lure unsuspecting retail investors into penny stocks. If you want to improve your understanding of topics concerning personal finance and investing; do subscribe to our blog and Youtube channel. You can also follow us on Facebook, Instagram, Twitter, LinkedIn.

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Penny stocks often have a poor compliance record and many of them cease to trade due to regulatory non-compliance/penal action. This is the biggest risk associated with penny stocks.

The bottom line

If invested thoughtlessly, penny stocks can be quite painful. They may dabble in unrelated businesses and you might struggle to know what exactly the core business of a company is. For every penny stock that becomes a long-term multi-bagger, there are countless penny stocks that trap investors. Be sure to analyse your choices and the market well, before betting your hard-earned money on penny stocks.

Disclaimer:

The blog is for information purposes only and anything mentioned herein shouldn’t be construed as a fundamental reason to buy/hold/sell any stock. Furthermore, the information provided in the blog and observations made there shouldn’t be treated as the extension of recommendations made on the other properties of Ventura Securities. If you follow any research recommendations made by our fundamental or technical experts, you should also read associated risk factors and disclaimers.

We strongly suggest consulting your financial advisor before taking any decision pertaining to your finances.

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to the blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in the securities of the company. We do not have any directorships or other material relationships with the company.

We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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