What are Penny stocks?
Penny stocks are those stocks whose share price is between Rs 0.05 to 10 and have a very low market cap.
Example : Essar Securities Ltd
Look at share price and Market Cap.
- SHARE PRICE :
- MARKET CAP :
SOME OTHERS PENNY STOCKS IN INDIA ARE
Difference between a small-cap and a penny stock
Small-cap stocks are defined by market capitalization, while penny stocks are defined by their price per share.
In short, the market cap of both is low but the main difference is in the share price.
- The small-caps stock price is above 10.
- Penny stock price is below 10.
Example : Safari Industries Ltd is a small cap stock.
- SHARE PRICE :
- MARKET CAP :
Penny stocks are extremely risky, but small-cap and micro-cap stocks include stocks with the potential for rapid growth.
What is the risk in penny stocks?
In general, all penny stocks have the following issue:
- The promotors are not ethical and honest
- Loss-making company
- Heavy debt
- ROCE is too low
- ROE is too low
- The promoter holding is too low
See the results of the last financial year of Suzlon Energy Ltd.
|Net Profit||Negative |
Penny stocks are illiquid by nature. In this type of stock, investors cannot find buyers or sellers due to limited trading.
Some days only buyers are there and some days only sellers.
EXAMPLE : STL Global Ltd.
Look here, there are only 25 stocks traded that day
UPPER AND LOWER CIRCUITS
The upper circuit is the range above which stock prices cannot trade on a particular trading day. The lower circuit, on the other hand, is the range below which stock prices cannot trade on a particular trading day.
- In general, SEBI imposes higher and lower circuit limits on all penny stocks and is a loss for investors.
- Suppose you are already an investor in a penny stock and you want to sell it. But you can’t sell one share because of a circuit every day.
- These are the stocks that had a daily upper circuit from May 18 to May 22. And most of them are Penny stocks.
Penny stock scandals are common in international financial history.
One such popular method is “pump and dump”. Companies and scammers buy significant amounts of penny stocks resulting in price inflation which attracts other investors to follow the hype.
However, once enough buyers invest in such stocks, such companies and scammers tend to sell their shares.
As a result of this, immediate value reduction is followed and losses are incurred after the unscrupulous investors try to sell it.
Given that companies issuing penny stocks are usually start-ups, there is a lack of information about their financial vulnerabilities, past performance, growth prospects, etc. Individuals can invest in it half-wisely. So, do thorough research on the list of penny stocks in India before investing.
Why do investors buy penny stocks?
Mostly, small investors invest in penny stocks, in other words retail investors.
Large investors such as foreign investors, domestic mutual funds and other large investors usually do not invest in these types of penny stocks because of the very high-risk associates with them.
Why do Retail investors buy penny stocks?
LOW PRICE :
- Penny stocks are usually traded at very low prices, so retail investors are attracted to them.
TO GET MORE NUMBER OF SHARE:
- Suppose an investor wants to invest Rs. 50,000. If he invests in HDFC Bank which is currently trading at Rs.1000, he will get only 50 shares. And instead if it invests in Unitech he will get 37,037 units.
TO MAKE QUICK MONEY MENTALITY:
- Suppose the share price of stock A is Rs. 2. Most retail investors believe that the stock could easily reach Rs.10 in a short time.so they invest in them.
- Most retail investor believe that low price means undervalue stock.
How Much to Invest In the penny stocks?
#1.DON’T INVEST TOO MUCH:
- Don’t over-invest on these risky investments. Penny stocks should not account for more than 10% of your total equity portfolio. This means that if your total investment portfolio is Rs 10 lakh, you should invest a maximum of Rs 1,00,000 in these high-risk stocks. Only invest what you can afford to lose.
#2.ONLY INVEST IN 2-3 STOCKS:
- The principle of diversity does not work here. Instead of choosing a large number of penny stocks, invest in just a few scrips. It is much easier to inspect 2-3 stocks instead of a low portfolio of 10-15. Price stocks.
#3. DON’T TRY TO AVERAGE YOUR PURCHASE :
- If you bought the stock for Rs 6 and now it is trading at Rs 3, do not try to average your purchase by buying more. You can dig a big hole for yourself and lose more money
# Case Study (Unitech Ltd)
That was the year between 2003-2007.
Everyone was interested in buying Unitech. At the time, Unitech did not have penny stock. The share price was Rs 550 in 2008.
But, why has Unitech become a penny stock today?
(Note: Data taken from www.screener.in)
- Between 2006-2008, in just 2 years, the share price jumped from 16.31 to 314
- Between 2008-2020, the share price fell from 314 today to 1.35.
Why did its share price keep going down?
- As we know, In the long run, the movement of share prices follows the company’s earnings.
PROFIT AND LOSS STATEMENT
From the graph, you see clearly
- Profit increased from Rs 87.65 crore to Rs 1661.86 crore between 2006 and 2008 ( 20 times increase in just 2 years and share price followed accordingly)
- The profit in 2006 was Rs 1661.86 crore. Then it kept going down. And made a loss of Rs 162 crore for the first time in the year 2014. Since then the losses have widened further and today’s loss is -790 crore.
RETURN ON CAPITAL EMPLOYED
- The ROCE of any company shows how the management uses the capital in the business and how much return it generates from this capital.
- Here, ROCE has been steadily declining since 2007, and ROCE has been negative for the last 4 years.
Conclusion: The main reason any stock falls into the penny stock category is weak fundamentals.
How to invest in penny stocks for beginners?
Penny stocks are risky. But today’s blue-chip was penny stocks in the past.
- Bajaj Finance was a penny stock in 2008. No one was interested in buying it. But today it is in bluechip stock.
SO,HOW TO INVEST IN PENNY STOCKS?
Here are some points to consider before buying it.
- Does it come from good corporate houses like Tata, Birla, or HDFC?
- have you found its products or services in the market?
- Do you like its product or services?
- Do Promotors holding in the company high?
- Does the company make a profit or loss?
- Debt Reduction.
- ROCE improving.
- ROE improving.
- Profit margin improving.
If you find all this in a company then you can buy a certain stock.
Has anyone made money from penny stocks?
Yes, he is Rakesh Jhunjhunwala.
It was the year 2003
Rakesh Jhunjhunwala had invested heavily in Titan Company.
Everyone was shocked.
No one could understand why Rakesh Jujunwala invested in Titan
But he is Rakesh Jhunjhunwala. No one can compete with him in the stock market. He is talented.
At that time, the share price of Titan Company was very low at around Rs.3 or 4 and the market cap was around 300 crores.
- Net profit was 6.21 crore
- The debt was 467 crore
- ROCE was only 3.01
Titan Company LTD: Journey from Penny Stock to Bluechip Company
I am showing you how Titan Company transfers itself from penny stock to blue-chip stock.
Here, we will apply the points discussed earlier.
(Note : All data has taken from www.moneycontrol.com)
Does it come from good corporate houses like Tata, Birla, or HDFC? :
- Titan is a Tata Group company, so there is no issue with corporate governance.
Have you found its products or services in the market? :
- My dad has been wearing a Titan watch for the last 30 years. Its product was very nice. It offers great products at a low price range.
Do Promotors holding in the company high? :
- In 2003-2004 , Promotor holding was 47.12%.
Does the company make a profit or loss? :
- From the table, Titan’s profit has increased from Rs 6.21 crore in 2003 to Rs 1927 crore in 2019.
- About 310 times in 17 years.
- The debt was Rs 442.15 crore and the profit in 2004 was only Rs 11.18 crore.
- Now, look at the company’s debt reduction plan which was significant. Each year from 2004 to 2011, the company repaid its debt by increasing its profits.
- In 2011, the debt was only Rs 57.1 crore and the profit was Rs 599 crore.and in 2019, it was 169.09 cr
RETURN ON CAPITAL EMPLOYED
- In 2004, the ROCE was only 3.01%. From there, it was steadily rising and in 2012 it was 39.36%.and in 2019, it was 32.45%.
PROFIT MARGIN INCREASING
- In 2004, the profit margin was only 1.24% and in 2019, it was 7.2%.
- The share price was only Rs 2.97 in 2003 and in 2019 it was Rs 1023.
- The share price rose 344 times in just 16 years.
- If you calculate the return, it is about 44.06% (CAGR)
If one had invested only Rs 1,00,000 in 2005, he would have had over Rs 3.44 crore in 2019.
This is the reason why everyone follows Rakesh Jhunjhunwala.
Final Thought On the Penny stocks.
- All penny stocks are very risky.
- Its fundamentals are very weak and his share price is unlikely to rise.
- Making money from penny stocks requires a very high level of research and business knowledge, but if you choose the right stock at the right time, you can make a lot of money from just one stock.
- It is beneficial for retail investors to stay away from these penny stocks and invest in the high-quality business.