What are Penny Stocks?

Penny stocks are a form of market traded security which attracts minimal pricing, mostly offered by companies with lower market capitalisation rates and are also called nano-cap stocks, micro-cap stocks, and small-cap stocks, depending on the company’s market capitalisation.

A company’s market capitalisation rate is determined based on the product of the current price of its shares or stocks and the number of outstanding shares. 

Classification of companies based on their market-capitalisation rates –

Penny stocks in India are, released by companies with market capitalisation lower than Rs. 5,000 Crore.

Features-

• These stocks provide much higher returns. Shares are issued by small and micro-cap companies, with vast potential for growth. Penny stocks are risky, given its intensity of response to market fluctuations.

• They are illiquid in nature, the companies issuing them are relatively unpopular. It becomes challenging to find individuals who are willing to purchase these stocks, offering little aid during emergencies.
•  In India, penny stocks are usually priced lower than Rs. 10. Purchasing a substantial amount of stock with a small-scale investment is possible.
• Unpredictable pricing: They might not attract adequate pricing during the sale, resulting in a lower or non-existent profit margin. These stocks could also attract a price significantly higher than cost giving a considerable profit.

Investment in Penny Stocks

Penny stocks can be considered a hit or miss security. But they should be included in portfolio because –

1.Some of these have the potential to evolve into multi-baggers. Shares which yield in multiples of the investment amount. If specific security reaps double its investment amount, it is called a double-bagger.They could increase return prospects and outperform the large and mid-cap funds. 

2.Investing in these stocks is comparatively cheaper. Allotting a small portion of portfolio to purchase the best penny stocks would still allow the leeway to invest in other more secure investment options reducing the risk factor associated.

Risks

Given the scale at which the companies offering such stocks operate, they are prone to huge risks. Other forms of risks –

• companies issuing penny stocks are start-ups, there exists a dearth of information on their financial soundness, past performance, growth prospects, etc. Individuals might invest in them half-wittingly. 
• Penny stock scams are commonplace. One such popular method is “Pump and Dump”. Companies and scammers purchase a considerable amount of penny stocks resulting in value inflation which attracts other investors to follow the hype. Once enough buyers have invested, such companies and scammers dump their shares, resulting in an immediate lowering of value followed by losses on the scrupulous investors’ end as they try to sell it.

Alternative Options to Penny Stocks in India

Individuals can also decide to invest in other options like Mutual Funds as investment pools that involve multiple individuals investing in a single fund which is then used to purchase securities.

A few MFs are listed below –

1. Large and mid-cap equity funds are employed to purchase equity shares and stocks from large-cap and mid-cap enterprises. These funds have moderate return capacity and entail lower risk compared to penny stocks.
2. Debt Funds are used to purchase fixed income securities and come with a lower risk factor. The return potential on such funds is limited to 12%.
3. Hybrid Funds are employed to purchase a mixture of market-linked and fixed income securities. The risk and return factor vary. These are a great option to diversify investment portfolio and balance the risk and returns.

They comprise of a massive volume of securities available in the market including large-cap stocks, mid-cap stocks, small-cap stocks, treasury bills, government bonds, debentures, etc. apart from penny stocks. Conduct diligence before selecting the right investment option according to financial objectives.

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Krishna Rath is a SEBI Registered Investment Adviser, and since 2015 has been educating netizens on investments and insurance. Krishna is a fee only SEBI RIA and is Odisha's first SEBI RIA. With background in IT, Krishna is changing the advisory space with new innovations in AdvisoryTech.

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