Investing In Penny Stocks: Fact vs. Fiction

Penny stocks, as the name suggests, are stocks of those companies that trade with a low share price, often for less than Rs 10. Given such a low share price, there is an understandable draw for retail investors who dream of buying 10 Rupee shares and seeing them rise to ten or more times that sum.

But before jumping into penny stocks, an investor should note several key factors that affect the way these stocks trade and have a solid understanding of the inherent risks that follow.

Is the Stock Worth Buying?

One of the biggest mistakes that retail investors make is that they view penny stocks as being affordable. There is a sense that one is getting a big bucket for their small amount when they buy thousands of shares rather than a couple of a company with a higher share price.

At first glance, this thinking seems rational because, after all, a 10,000 investment in Company A that trades at Rs. 10 allows the investor to buy 1,000 shares, rather than 100 shares of Company B that trades at Rs. 100. A key piece of information that is often overlooked is the number of shares outstanding.

Let’s assume that Company A and Company B shared identical fundamentals with the exception of the number of shares outstanding. For simplification, let’s also assume both companies have a market capitalization of 10 Crore.

When the share price is the only factor taken into consideration, a retail investor might think that the quality of the firm trading at Rs. 100 is much higher than the one trading at Rs. 10. As we’ve seen in the example, this may not always be the case since they are identical, so it is important to consider the number of shares available.

How to Spot the Right One

Most companies that trade with share prices under 10-20 Rs. have relatively small market capitalizations, but as shown above, this doesn’t always have to be the case. When it comes to investing, it is important to consider the strength of the company’s fundamentals.

Read in Detail: Fundamental Analysis vs Technical Analysis

Does the management team rely on issuing new shares to raise capital? Is the company profitable or will it be able to turn a profit based on its current business structure? Can the company compete in its sector? For those willing to do their homework, there are definitely gems that can be found that meet these criteria.

Points to Understand

Penny stocks, or securities that typically trade for under Rs. 10, are appealing to investors who see them as a way to make easy money, but there are many risks that are often overlooked.

Some penny stocks are good stocks that have become devalued for a variety of reasons and have the potential to rebound, while others have little chance of recovery and could be a money pit.

The share price does not always speak to the quality of the company, so investors need to consider the number of shares available, share liquidity, and the risk of dilution if there are too many shares outstanding.

Read: Risks and Rewards of Investing in Small-Cap Stocks

Following are the Group X Penny stocks which locked In Upper Circuit on Friday:

Following are the Group A & Group B Penny stocks which were trading on their 52-week High on Friday:

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.