Stock market investments can be highly rewarding, especially if an investor is experienced and makes informed decisions. With a variety of stock options in the market, traders can invest in well-established, mid-range or even small companies. Many traders, however, tend to prefer well established or mid-range stocks. These are appealing mainly because of the company’s reputation gained from steady revenue generation over years. Investing in small companies, on the other hand, is considered risky but still attracts some sections of investors.
Here, we will discuss penny stocks and explore their features to gauge whether it makes sense to invest in them.
What are penny stocks?
While browsing through the stock market investment options, investors may come across the term penny stocks. These are small-cap company stocks that are available for very low prices. That is why the name ‘penny’. This feature can attract many investors since more investors can afford to buy penny stocks with the available capital.
Penny stocks usually trade at very low market prices, generally around Rs. 10. These stocks belong to companies with very low market capitalization, usually under Rs. 500 crores. Penny stocks typically have low liquidity in the Indian stock market. However, there are a number of penny stocks listed on both the Bombay stock exchange (BSE) and the National stock exchange (NSE).
Since penny stocks belong to companies that are smaller than small-cap companies, these fall under the micro-cap category. These investments are speculative in nature.
Here is an example to understand penny stocks. Suppose an established company’s stock price is Rs. 500 whereas a penny stock comes at Rs. 5. An investor with a capital of Rs. 10,000 can buy only 20 shares of the well-established company. On the other hand, they can buy 2000 penny stocks with the same amount of capital.
Additional read – Most expensive stocks in India
Features of penny stocks
Here are the main features of penny stocks:
As mentioned earlier, penny stocks in India come under Rs. 10. Thus, one can buy a large number of shares with limited capital on hand.
In comparison to other forms of securities, penny stocks may have the potential to offer high returns of investment. Since these belong to small-cap companies, they may have a huge potential for growth. However, high returns come with higher risks. Therefore, investors should be ready to take on higher risks while investing in these.
Lack of price prediction
Penny stocks may not necessarily reach an adequate pricing level. However, there are also chances that penny stocks surge above the average prices. This is mostly unpredictable.
Additional read – How to analyse a stock to invest better?
What are the risks involved in penny stocks?
Although penny stocks can be profitable at times, there are also risks associated with penny stock investments. Here, the loss potential is comparatively high. Before investing in these, investors should know about the below-mentioned risks:
The price movements associated with penny stocks are usually high, but also volatile. This could be a red flag, especially if investors are looking for liquidity. The faster the price rises, the faster the price drop in this case. Thus, if an investor wants to liquidate the investment but does not time it well, it can result in losses or investors may be forced to stay invested for an unpredictable period. Penny stocks are often difficult to buy since there are not many sellers during high demand phases.
Most investors invest in penny stocks with an expectation that the small-sized company will be a blue-chip company someday. In many cases, however, this may not be as expected. Small-cap companies may or may not have a consistent and profitable future. Thus, penny stocks are often inconsistent with returns.
Prone to scams
Penny stocks are often prone to scams where companies buy a substantial amount of penny stocks to artificially inflate their value. This attracts investors, but they end up making losses once the scam is discovered.
Should you invest in penny stocks?
Penny stocks are best-suited to investors who have a significantly high risk tolerance with an expectation of fetching higher returns. Investors who have a low-risk appetite should stay away from these stocks. Penny stocks can be about the hit-or-miss game. On one hand, these companies may grow into larger establishments and fetch higher returns or these may go down by incurring huge losses.
While penny stocks have their set of risks, these can be included in an investor’s portfolio. Here are the reasons why –
Some penny stocks can have the potential to fetch multiplied earnings. Thus, some of these could generate earnings in multiples of the original investment amount. Including these stocks in an investment portfolio can significantly increase an investor’s return prospects. Some stocks may even outperform large and mid-cap stocks. It is, however, important to do detailed research on selected penny stocks to know which ones can multiply portfolio earnings.
Cheaper than other investments
Penny stocks are comparatively cheaper than other stocks or investments. This allows investors to invest in them without fearing huge losses. A small percentage of a portfolio allotted to the best penny stocks can allow an investor to allocate the remaining portion to more secure investment options. This also helps in balancing the overall risk factor.
Penny stocks are no doubt risky and often lacking sufficient information about the company. Despite this, many investors make substantial gains from these. It is all about conducting a good amount of research before going for penny stocks. A small percentage investment in these can go a long way in wealth creation if done wisely and with appropriate risk balancing.
To choose penny stocks, it is important to understand the market along with conducting basic research on different stock categories. By understanding stock prices and valuations, one can identify penny stocks that can be further studied to avoid pure speculation.
There is no defined limit up to which a penny stock price can go.
When penny stock prices rise and remain stable over a longer period, it may be because the company has achieved a certain level of growth. This could signal that the stock price may have entered small or mid-cap levels and may no longer be a penny stock.
To start investing in stocks in India, the first step is to know the reason why you want to invest in stocks and have clarity of goals. By opening a demat and trading account alongside setting up a budget, you can be good to begin investing in stocks.
Although penny stocks are cheap and may attract all kinds of investors, beginners may not be able to make the most of these since it requires detailed research and basic knowledge of stock markets.