Penny Stocks - To Buy Or Not?

Many a times people keep searching for penny stocks to buy. As the markets get enveloped in a bear hug, the search for value makes many an investor look at the ‘penny game’ -- looking for stocks that have lost 90% from their tops and are quoting in single digits.

Just as low-priced food, apparel or cosmetics catch the eye of the price-conscious consumer, penny stocks — or scrips that are quoting in single digits — cast their spell on the investor. But before an investor has a shy at these penny stocks, it might be well worth his time to ponder over a few points.
Cheap can become cheaper
A stock that has corrected to Rs 10 from Rs 100 could possibly nosedive to Re 1.

If you are not sure that at Rs 10, the scrip is undepriced, avoid it. Bad businesses can quote even below the current ‘low’ prices.

Don’t jump to buy one before you probe into the reasons behind such steep falls, for the stock could well test a new low.

Check the face value and valuations
A stock with a face value of Re 1 that quotes at Rs 15 is at the same price of a stock that quotes at Rs 150 with a face value of Rs 10, other things being constant.

The factors such as valuations and business prospects are next checkpoints, before you decide to invest.

Most penny stocks suffer from lack of information. Unlike Nifty stocks, which enjoy adequate coverage by brokers and where most of the information is available in the public domain, there is a lot of uncertainty around penny stocks.

Investors have to be careful while putting money in penny stocks, especially ‘turnaround stories,’ as you may be the last person to know about the ‘story’. No wonder these stocks are viewed as an operator’s paradise.

Gullible investors turn out to be the scapegoats as the stock is distributed mostly by the operators.

It is an issue with these counters. This ensures that the price moves in either direction quickly, and a couple of circuits, is ‘business as usual’ for such scrips. In other words, if you realise your ‘mistake’ a bit too late, an exit may not be possible at all, especially if you are stuck with a substantial lot.

Illusion of small: Many think that the penny stocks move quickly to double in price. But this is not the case.

Other things remaining constant, if a company can double its earnings, the stock has the potential to double irrespective of the price level.

Low risk?
Some look at stocks from a ‘low risk’ point of view. When a company sinks, the stock may not remain on the buy list of investors. In the worst case, the price can touch zero.

A stock that was bought at Rs 10 becomes a worthless piece of paper and the investor faces ‘loss of capital’ — the worst that can happen in equity markets.

Put simply, the penny nature of a stock is conducive neither from the risk perspective nor from the reward point of view.