How To Beat The Penny Stocks At Their Own Game Of Uncertainties

There’s a certain excitement in playing the stock market. Hearing now and again the success stories of investors who have made a fortune in the stock markets certainly enlightens us and puts dollar signs in our eyes, propelling us to move forward with our own investment portfolio. However as we all know successful investing in the stock market needs a careful study and diligent strategising. Uncertain circumstances, moreover bearish trajectories often make wealth creation a challenge, and one needs to be constantly on the vigil.

There are a few superstars out there who have overcome challenges and made investing look like a cake walk; and have entered the “Hall of Fame”.  They endure, or even thrive in the storms of the market. These individuals are praised as the gods of the investing world and are appreciated worldwide for their style and approach of investing. Individuals who belong to the list of ‘the best investors’ in the world not only have massive amounts of money for themselves, but also have widespread experience and leave behind a legacy.

Nonetheless, it has been marked that these investors are in contradiction as regards the strategies and philosophies they applied to their investing journey. Some came up with a new and innovative way to analyse stocks, while others picked stocks based on orthodox methods which best suited their style. However they are all birds of the same feather in as much as taking home handsome profits.
[PAGE BREAK]

Following are some of the world’s super star investors and the ideologies followed by them for investing as per ‘investopedia’:

·         Benjamin Graham: He is universally recognised as the father of two fundamental investment disciplines-security analysis and value investing.

·         Peter Lynch: Often described as a ‘Chameleon’, Peter Lynch adapted to whatever investment style worked at the time. But when it came to picking specific stocks, Peter Lynch stuck to what he knew and/or could easily understand.

·         George Soros: George Soros was a master at translating broad-brush economic trends into highly leveraged, killer plays in bonds and currencies. As an investor, Soros was a short term speculator making huge bets on the direction of financial markets.

·         Warren Buffett: Referred to as the ‘Oracle of Omaha,’ Warren Buffet is viewed as one of the most successful investors in history. Buffett’s investing style of discipline, patience and value has consistently outperformed the market for decades.

·         John Templeton: One of the century’s top contrarians, it is said about John Templeton that he bought low during the Depression, sold high during the internet boom and made more than a few good calls in between.

Majority of the above investors have a fascinating story to tell. However, one of the investors whose investing style matches our story of penny stocks is John Templeton.

Story of ace investor John Templeton

John Templeton was one of the great legends of investing. Born as a pauper in Tennessee, USA, John Templeton moved out of poverty by utilising his thinking skills. He went to Yale University on a scholarship and graduated with a degree in economics in 1934. He additionally was a Rhodes scholar and earned a master of arts in law.

When he went to New York in 1936, he worked as a trainee for Fenner & Beane, which converged with Merrill Lynch in 1941. In 1939, when Hitler and the Nazis were vanquishing from a large portion of Europe, stock prices were depressed, and in most cases stocks were trading for less than their scrap value. Templeton, by then an ‘experienced’ 27-year-old, considered this to be an open door and started purchasing stocks. He placed orders to buy $100’s worth of every stock trading for less than $1 per share (termed as penny stocks).

In all he accumulated the stocks of 104 companies, of which 34 went bankrupt. However, this total investment of $10, 400 was sold four years later for more than $40,000. He was one of the investors who made records in the history books of investors for making a fortune from penny stocks.

What is a penny stock?

Penny stocks have a broad range of definitions. By definition, penny stocks are those that are traded at very low prices-almost below face value or Rs 10 in the Indian context. They are volatile, and low market capitalisation makes them susceptible to manipulation by promoters who hold majority of the stocks, termed in the market parlance as pump and dump. As per Securities & Exchange Commission (SEC), USA, penny stocks are generally stocks issued by small companies which trade at less than $5 per share.

Penny stocks are highly speculative and the odds of losing entire investment in a penny stock are far greater than is hitting a home run and raking in huge profits. On the other hand, these stocks are quite popular amongst the investors as these stocks are priced low, and even a slight absolute rise can have a significant impact on returns. To cite an example, if a stock priced Rs 2 goes up to Rs 4, it is a 100 per cent jump.

What makes investing in penny stocks so attractive?

Penny stocks are quite lucrative and you might be wondering why. There are several distinctive reasons, particularly novice traders or investors get attracted to penny stocks because of two primary reasons:

Ø  Huge Potential- Multibagger.
Ø  Low Cost Price

1.       Huge Potential- Multibagger:

The number-one reason people get involved in penny stocks is that it has huge potential to make an investor rich in quick time. As per the thumb rule of investing, it is about purchasing the right business or stock at a right valuation. But, it has been observed that majority of the general investors believe that buying a low-cost stock or a penny stock will help them make a fortune in a jiffy. Yes, previously there have been various examples of overcoming adversity wherein stocks have soared considerably. Investors need to remember one thing every single penny stock is not a multibagger. Penny stocks are generally such sort of investments where 8 out of 10 stocks will fizzle and the remaining two stocks will take years to give you a fortune as the small companies need time to let their business plan play out and stock prices gradually reflect the improving operational results. So most of the people often burn out and collapse their account without knowing what they are doing.

2.       Low Cost Price:

The second primary reason the crowd on the D-street is attracted to the Penny Stocks is that the investor gets a large number of shares at a small total value. Some beginners who invest in the stock market usually don’t have a large portfolio sum or capital amount. For example, if a company named ‘XYZ’ is trading at Rs 5 per share, an investor who has capital of Rs 10,000 can buy 2000 shares of ‘XYZ’. On the other hand, if he was to pick a blue-chip company like ‘Reliance’ with a current market price of Rs 975, he would only get approximately 10 shares, and as described earlier a minimal increase in penny stocks can give large returns percentage wise.

Threats associated with investing in Penny Stocks

1.       Manipulation:

Manipulation is easier with low-priced stocks. For example, if you spend Rs 5 lakh on a penny stock, you can move the stock several points. It takes less capital to move a penny stock. When you see a move in these penny stocks, you don’t know whether this move is a real move or someone is manipulating it.

2.       Getting delisted:

It has been observed in the past that penny stocks are very often delisted. Recently, the top exchange BSE has been very strict and has suspended numerous stocks. There are companies whose promoters might have vanished after duping the investors, while there are others who do not want to pay the penalties to revoke the suspension.

3.       Circuit limits:

Penny stocks have Circuit limits. Circuit limit means a stock price cannot increase/decrease beyond a pre-determined percentage. As investors it’s difficult to ride a stock which has circuit filters. It has been observed that once these penny stocks start hitting lower circuit, it’s hard to sell such kind of shares and end result is erosion of capital.

4.       Liquidity:

Several penny stocks generally trade at low volume. Means selling quantity of 2000 shares at Rs 7 is not possible if the total quantity traded in the stock is 1000 shares. As a result, it can be increasingly difficult to find a buyer for that particular penny stock until it dips lower. Another hindrance is that there are chances of a ‘pump and dump.’

5.        Lack of available information to the public:

In penny stocks there is low transparency of information; it becomes increasingly difficult for investors to make a properly informed decision when there is low transparency.

Important guidelines before investing in penny stocks:

Despite the threats associated with investing in penny stocks, investors and beginners keep pouring money in low priced penny stocks. However, if you as investors want to invest in this risky segment of the market you must keep a few important guidelines in mind.

1.       Don’t keep your portfolio restricted to the penny stocks as there are huge risks associated with these penny stocks, as the popular saying goes, “Never place all your eggs in one basket”. Hence, keep a diversified and a balanced portfolio i.e. mix of large cap, mid cap and limited penny stocks which have a good history.

2.       In the universe of penny stocks, concentrate on those with higher volumes, but when it comes to volume, there are actually two things to be considered. First, you have to pay attention to daily trade volume. It’s better to get involved in stocks that trade a minimum of 100,000 shares a day. Any less than that is a high concern as low volumes are an exemplary buyer’s trap. Secondly, look at volume in terms of your position relative to the company’s volume. If you get into a stock for more than 10 per cent of its daily traded volume, it gets much harder to get out of a position quickly. Hence, always select stocks where you see high volume of trading.

3.       Get out of trade and apply a “stop loss” when they don’t go your way. This is one of the important guidelines for penny stock investors. It is much easier said than done. Putting this rule in place and following it all the time is the best way to protect yourself from the downside risk of big losses on unpredictable stocks. 

4.       As soon as you identify a valuable penny stock, the basic rule for buying the penny stock is to slowly accumulate in tranches. If you want to allocate Rs 25,000 to a penny stock, don’t do it all in one shot. Phase out your buying in a sensible manner or through continuously monitoring the development in the stock.

5.       One important rule which should be adopted in the case of penny stocks is that these stocks witness fast & furious moves. If an investor boards the penny stock and if it appreciates over 50 per cent in a short span, it’s better to withdraw your initial capital and keep shares which are earned from profit.

6.       Never invest more than you can lose in the penny stocks. In simple terms it means don’t lean too much on these risky investments. Penny stocks should not account for more than 10-15 per cent of your total equity portfolio.

7.       Try not to trust anybody when it comes to investing in penny stocks. Tips by broking firms are often misleading and may leave you cash strapped.

 

[PAGE BREAK] 

Best-performing Penny stocks in the last five years

In Indian stock market we have seen many stories of penny stocks becoming multi-baggers over a period of time. In the last five years, stocks likes Indo Count Industries; Cupid; Marksans Pharma; Welspun India; and Northward Technologies are part of the hitlist. The difference between a good prospect and a junk penny stock is the quality of management, supported by high quality business model and fairly sustainable cash flows.

Worst-performing stocks which became penny stocks in the last five years

Of course, if there is a bright side, there has to be a dark side to the story. Indian stock market has its fair share of high priced stocks which gradually dissipated into becoming a worthless stock on account of bad management decisions, too much debt and lack of reliable profit models, that took their toll.

 

Company Name	BSE Code	June 13 2012	June 13 2016	5 years CAGR return
Tuni Textile Mills	531411	131.6	0.5	-75.30
Kyra Landscapes	530967	76.1	0.3	-74.34
Indian Infotech & Software	509051	23.9	0.1	-72.32
Core Education & Technologies	512199	307.2	1.9	-72.11
Luminaire Technologies	526045	32.2	0.2	-71.93

Finding the right needle(s) from the enormous haystack

To conclude, we are not conveying that all the penny stocks are a scam or junk. But the big challenge in the penny stock is ‘to find a needle in a haystack’. The probability of striking a multi-bagger penny stock is extremely low. It is essential for investors to understand the contrast between a low-priced stock and a modest stock, which is exceptionally a murky task. Cheap stocks are cheap for a reason and adding stocks which are touching new lows daily is a bad idea. But the greatest test in any penny stock is in recognising, buying and eventually holding on to the stock to exit profitably. That is the key. Reconsidering John Templeton's case, in all he accumulated the stocks of 104 companies, of which 34 went bankrupt. However, this total investment of $10, 400 was sold four years later for more than $40,000. So it’s important to follow the guidelines mentioned above while investing in Penny stocks.