What are penny stocks?

There is no theoretical definition for penny stocks. However, stocks that trade at single-digit prices with low market capitalizations are bracketed in this club. Some typical characteristics of these stocks tend to be low promoter holding, huge debt, accumulated losses, and poor dividend track record. However, stocks like Vodafone Idea, Yes Bank, and Suzlon Energy, which now trade at prices of less than Rs 10 with a huge equity base and market capitalization of nearly Rs 26,000 crore, 25, 000 crore and Rs 3,232 crore, respectively, do not fall in this basket.

Making money with penny stocks

Penny stocks are highly risky, but some of them also have the potential of turning a small investment into a fortune. For example, if you own 10,000 shares of a penny stock priced at Rs.5, even an Rs.1 rise in the share price can give you Rs. 10,000 in a single day. This is not possible in the case of a large-cap stock, because it would require large capital to buy such a large volume of shares.

What are the risks of penny stocks?

Penny stocks are very speculative in nature and are considered highly risky because of lack of liquidity, a smaller number of shareholders, large bid-ask spreads, and limited disclosure of information. Typically, penny stocks have a higher level of volatility, resulting in a higher potential for reward and, thus, a higher level of inherent risk. Investors may lose their entire investment on a penny stock.

Things to keep in mind while picking a penny stock

  1. If at all, one should buy such stocks only if it has a reasonably high trading volume which would suggest heavy liquidity.
  2. While picking a penny stock, one should check any working capital stress and debt level. Usually, they are huge enough to kill stock and get it delisted from the stock exchanges. One can also eliminate stocks based on parameters like debt being in multiples of annual sales and low promoter’s stake.
  3. If you bought a share at Rs 10 and it now trades at Rs 5, don’t try to average out your purchase by adding more of it. You may end up digging a deeper hole for yourself and lose more money. Don’t get attached to a price and be ready to book losses if an investment goes wrong. You should improve the average by selling some shares when the price starts moving up, than buying more when it goes down.
  4. Ensure that only a small amount of the portfolio is invested in such stocks, not exceeding 10 to 15% of the portfolio.

Penny Stocks in India

Following is the list of top-performing penny stocks

Disclaimer: I cannot guarantee the returns of investment. You are buying stocks at your own risk and reward.

Closing Thoughts

Are all penny stocks bad? The answer is No. there are always a few good companies, ignored or under-researched companies which can make hefty money for investors. Hence, one should focus on companies with strong financials and quality management.