Don’t let mind-boggling returns cloud your judgment

To make sure, a lot of the run-up within the firm’s inventory value got here not too long ago on again of a extremely worthwhile December quarter in FY22, after a number of quarters of losses.

Penny shares appear to be fairly fashionable amongst many retail traders, as a result of steep returns that a few of them have delivered. Out of all penny shares listed on Bombay Stock Exchange (BSE) and National Stock Exchange (NSE), the 448 shares which have disclosed their newest shareholding reveals retail traders have 20% or extra shareholding in practically 40% of them.

The lure of creating giant positive aspects shortly with minimal funding attracts retail traders to those penny shares.

For the identical sum of money, they will purchase lots of shares in a penny inventory as say a bluechip firm. For instance, an investor will get 39 shares of Reliance Industries for an funding of ₹1 lakh. For the identical quantity, the investor would get 25,000 shares in Vikas Ecotech, a penny inventory value ₹3.85.

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Due to their low base, a small achieve on the inventory costs of such shares quantities to giant positive aspects by way of share. But do the rewards outweigh the dangers that these penny shares carry?

More misses than hits

An evaluation of the previous five-year efficiency of penny shares the place retail traders had excessive shareholding (20% or increased) as of September quarter 2017, reveals that a little bit over one-third of such shares delivered near Nifty 50 index returns or increased during the last 5 years (see: graphic).

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However, what’s extra regarding is that a big chunk of such shares — 42% — had been suspended or faraway from exchanges. The suspension was both resulting from violations, or default on annual itemizing charges or restricted buying and selling as these shares had been put underneath surveillance watch by the inventory exchanges. Some of those had been merely faraway from exchanges after being suspended from an extended interval. One-fourth of those penny shares lagged far behind the 71% returns (in absolute phrases) clocked by the Nifty 50 Index during the last 5 years.

Penny inventory for a cause

To make sure, there have been penny shares that delivered multi-bagger returns (greater than 100%) in previous 5 years, however this was nonetheless simply one-third of the 456 penny shares’ universe.

Hemang Jani, head-equity technique, broking and distribution, Motilal Oswal Financial Services (MOFSL) says, “If traders punt on penny shares simply going by shares recommendations on some social media platform or market rumours, they’re doing nothing to scale back the likelihood of shedding their capital in such penny shares.”

“If they still wish to take their chances, it is important that they do some due diligence on their own to figure out what could be the factors that could lead to a re-rating of the stock or a turnaround of the company,” he provides.

Many penny shares can be found at such low inventory costs right this moment due to worsening enterprise fundamentals. It may be resulting from a heavy pile of debt, disruption triggered resulting from competitors or entry of latest participant, or the services or products itself going out of use.

Take the case of Vodafone Idea, whose share trades at simply ₹8.58. Apart from heavy debt, the inventory has been overwhelmed down as a result of aggressive depth within the telecom trade after the entry of Jio. Retail traders maintain about 6% in Vodafone Idea.

Deepak Jasani, head-retail analysis, HDFC Securities, says that a number of penny shares have misplaced worth throughout dangerous instances. “Investors assume that as a result of costs are so low-cost, it’s unlikely for such shares to see additional correction and therefore there’s a margin of security. But this isn’t the fitting understanding of margin of security,” he adds.

Promoter competency and corporate governance standards are also things to watch in certain penny stocks. Some of these stocks are easy to manipulate due to their low volumes. So, by creating artificial volumes, prices of certain penny stocks can see sudden spurts, to allow exit for certain sets of investors or promoters.

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Not for small investors

The high-risk in penny stocks don’t make them suitable for small investors. If the investor ends up making a wrong bet, he can see a sharp capital erosion and the lack of liquidity may not even let the investor exit his position to cut losses. Penny stocks don’t see much volumes on the exchanges.

Jani of MOFSL says that penny stocks are not meant for small investors. “A high net-worth investor (HNI) can take risk with a small part of his portfolio and still make a meaningful bet on a penny stock. However, a small investor may end up putting a large part of his net worth at risk when punting on a penny stock. So, he stands to lose a lot more on such investments,” he provides.

Beyond inventory costs

An inexpensive inventory would not essentially imply a pretty inventory. The low-cost valuations must be seen with future prospects of the corporate, catalysts for a turnaround and administration high quality. Its balance-sheet may be weak resulting from excessive debt or excessive stock, however are there indications that the administration is working to restore it or seeking to enterprise into new companies to revive the corporate? If not, the penny inventory is prone to stay one.

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