Should you buy penny stocks?

While a little more than 140 penny stocks have doubled in value, 555 have given negative returns in the past year.
Of these, 84 shed more than half their value.
Experts tell Ashley Coutinho about the risks involved.
Illustration: Uttam Ghosh/Rediff.com

A rising tide is said to lift all boats and the surge in the share market has done this with lesser known stocks.

The value of many penny stocks doubled over the past year.

Data compiled by the Business Standard Research Bureau show 145 of these scrips gave a return in excess of 100 per cent; a dozen gained more than 300 per cent.

In contrast, the benchmark BSE Sensex rose only 23 per cent, while the BSE MidCap index gained 40 per cent.

Penny stocks are those available in the Rs 1 to Rs 10 price range, with market capitalisation (m-cap) less than Rs 100 crore. These are considered high-risk investments, with low trading volumes.

They are also not covered by most brokerages, which typically look at stocks with an m-cap of Rs 300 crore or above.

"Most of these firms do not have a sound business model, fixed assets or income base. Retail investors should be cautious, as it is possible to lose 50 to 90 per cent of one's money in these stocks. Or the entire capital if the stock is suspended for trading," said G Chokkalingam, founder, Equinomics Research and Advisory.

Around a tenth of these scrips might rise for fundamental reasons but most are run-up by operators, who use the capital given by promoters of these firms, he added.

Indeed, while a little more than 140 penny stocks have doubled in value, 555 have given negative returns in the past year. Of these, 84 shed more than half their value.

"Investors get taken in by the euphoria and invest in penny stocks when the markets are rising, in the hope these stocks will easily double in value," said A K Prabhakar, head of research at IDBI Capital Markets.

"When the euphoria fades, investors are unable to exit due to the low liquidity and are left holding these duds," he adds.

Penny stocks that have shown a sharp price surge have also come under the radar of stock exchanges.

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A few months earlier, BSE and the National Stock Exchange put several companies under a graded surveillance framework, wherein their securities shall be subject to enhanced monitoring.

This is to alert and advise investors to be extra cautious while dealing in these and for market participants to do the needed due diligence.

According to news reports, the income tax department and the Securities and Exchange Board of India have also increased their scrutiny on penny stocks, with the Prime Minister's Office sending details of 80 such scrips last month.

The possibility exists of laundering undisclosed money by manipulating of listed penny stocks, to claim bogus long-term capital gain.