Penny wise? Look before you invest in penny stocks

During a bull run, investing in penny stocks may look too tempting to invest in but weigh the pros and cons and then go ahead.

April 30, 2015 9:44 IST | India Infoline News Service
In the last one year, since Modi Government has come into power, the Indian stock markets have performed exceptionally well. Stock prices of almost all companies have jumped up and retail investors have all the reason to cheer. Having said that, as an investor, if you are looking to invest in penny stocks for higher returns, think again. While it may be too tempting to invest in such stocks, weigh the pros and cons carefully.

A penny stock trades at a very low price, generally below Rs. 10, in India. These stocks are issued by companies who have a low market capitalisation.

Below are some of the things that you should look at below investing in a penny stock:

Do a thorough background check: Penny stocks are traded at a low share price and investors can make money in them when there is an overall rise in the share prices, owing to the overall rise in the indices. However, it is important to check the fundamentals of the stock before investing as there could be a risk involved. For instance, if you wish to buy stocks, you may feel that it would be quite expensive to go for good company stocks like Tata Consultancy Services or TCS that are currently quoting at Rs 2480 levels, as you may get to buy only two shares of them. At the same time, if there’s a smaller company stock trading at lower levels say, below Rs 10, you would like to opt for the latter as you get to hold a larger quantum of shares. Sometimes you may also feel that good company stocks haven’t given you the returns, as expected, as against penny stocks that have given a higher return. While the decision to buy ‘a particular stock’ will differ from person to person, it is better to evaluate the value of the stock, the credentials of the company, its long term plans, strategies and so on, before going ahead. Instead of focusing only on the number of shares, gains it has offered; do check the track record, earnings record and the returns offered by the stock in the past. Know the management of the company you wish to invest in. Stay informed.

Manipulation: Penny stocks generally have lower volumes and hence can be easily manipulated by market participants, especially by its promoters. It is important to stay informed about the latest developments of the company, if you intend to buy a penny stock, as most of them they are manipulated. It is important to study the stock in detail as most penny stocks belong to companies who are not transparent in giving out information. Going through the company’s annual reports or attending their annual general meetings would help you to understand the future of the management or its promoters.

Misleading stories: Many-a-times, stock brokers and small players can mislead you, by offering you tips, on buying penny stocks, saying the stock will or is shooting up by 100 per cent or more. At such times, as an investor, you should always question your broker on the fundamentals of the company, its future prospects and check for reasons as to why the stock is moving up or will move up. Do not get swayed by any success stories or any positive reports told by anybody.

If you are a first time investor: Experts suggest that it is always better to stay away from investing in penny stocks, if you are a first time investor in the stock market. In the last one year, some penny stocks have done well but then it was because of the overall climb in the stock markets. You may not have the knowledge or the expertise if you are investing in the stock market for the first time, and hence staying away from trading in penny stocks is a wise decision. Again, such stocks have low liquidity. Since penny stocks purely trade based on the demand from promoters, they may be locked in the upper or lower circuit for few days.

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