What are Penny Stocks? Characteristics, Risks, and Advantages

As humans, we are attracted to things that are extremely cheap. So, it is no surprise that as investors, we are fascinated by cheap stocks, also known as Penny Stocks. Penny stocks are extremely popular among retail investors as they trade at dirt-cheap prices. This allows them to buy a huge chunk of shares by investing mere hundreds or thousands. Also, the potential upside is unlimited. For instance, Adinath Textiles’ is a microcap company. Its shares were trading at Rs 1.71 on 1st January 2021. By 7th September 2021, its share price was Rs 49.20. This penny stock has delivered 2,777% returns in just 6 months! This jaw-dropping return potential is what attracts retail investors to penny stocks. If only you knew that this stock was available at this cheap rate and that the price would skyrocket … Isn’t that what you are thinking? But wait, before you invest in penny stocks, it is important for you to understand the risks that come with penny stocks. In this article, we will cover –

1. What are Penny Stocks
2. Features and characteristics
3. How to analyse and investing in penny stocks
4. Risks of investing in penny stocks
5. Four points to remember before investing in Penny Stocks
6. Brokerage while trading penny stocks

What are Penny Stocks?

The concept of penny stocks originated in the United States of America (USA). It is derived from the unit of currency called the penny. It is equivalent to one-hundredth of a US dollar. Penny stocks or penny shares are stocks which trade at a low price and have extremely low market capitalisation. The definition of penny stocks varies from country to country. For example, in India, stocks that are trading below Rs. 20 are commonly known as penny stocks. Whereas in the USA, stocks that are trading below $5 are considered as penny stocks. While in the United Kingdom, penny stocks are stocks that are trading below £1.

How to find out if a stock is a penny stock?

Penny stocks are generally offered by companies with lower market capitalisation. Hence, penny stocks are also called nano-cap stocks, micro-cap stocks, and small-cap stocks. A company’s market capitalisation is determined by multiplying its current share price with the number of outstanding shares. The following table demonstrates the classification of companies based on their market-capitalisation rates –

Classification	Market Capitalisation
Large-cap companies	Rs. 20,000 Crore or above
Mid-cap companies	Rs. 5,000 Crore – 20,000 Crore
Small-cap companies	Rs. 500 Crore – 5,000 Crore
Micro-cap companies	Rs. 100 Crore – 500 Crore
Nano-cap companies	Below Rs. 100 Crore

Penny stocks in India belong to companies with market capitalisation lower than Rs. 5,000 crores.

Let’s understand the features and characteristics of penny stocks.

1. Low liquidity

Penny stocks in India are generally illiquid in nature. This makes it challenging to find investors who are willing to purchase these stocks. One might not always be able to sell the stocks at the right time. Hence penny stocks are not a wise investment decision especially during an emergency.

2. Limited historic information

Penny stocks are issued by relatively young companies. Hence, there is limited historical information available in the public domain. Such companies usually lack a good track record regarding operations, and revenues. Limited information thus makes investing in penny stocks extremely risky.

3. Multibagger Stock

Penny stocks have the potential to provide higher returns than other types of securities. Some penny stocks have the potential to evolve into multi-baggers. It means that the stock will yield in multiples of the investment amount. For example, if a particular stock reaps double its investment amount, it is called a double-bagger stock. If the returns are ten times its investment value, it is said to be a ten-bagger stock.

4. Low-cost: 

Investing in penny stocks is comparatively cheaper. Penny stocks in India are usually priced lower than Rs. 10. This tempts investors to buy substantial quantities of penny stocks       with less capital.      .

How should one go about analysing and investing in penny stocks?

Penny stocks are riskier than the blue-chip, large cap or mid cap stocks. However, they present us with huge growth potential. But not all penny stocks outperform other investment options. This is why penny stocks are not recommended for investors with low-risk appetite. Your investment portfolio must be diversified. You must not invest a major portion of your corpus      in penny stocks. Penny stocks usually lure retail investors for their cheap availability and their potential to become multi-baggers. But remember, high returns come with high risks. In this video, we have discussed a model portfolio of five best penny stocks in India which you can buy keeping your risk appetite in mind. The video will also enable you to make your own checklist of factors to check before identifying penny stocks for long term investing. Watch: How to Analyse Best Penny Stocks in India

Risks of investing in penny stocks 

Penny stocks are highly lucrative if you do your homework before investing in them. Though there is only limited information available, you must learn how to make the most of the data available. If you are able to find and invest in a fundamentally strong penny stock, you can make an enormous fortune. Recommended Read: Five-Step Framework to Company Analysis Penny stocks have extremely low trading volumes.     s. This makes them an easy target to manipulate the stock price. Unethical operators would invest or dump penny stocks in  large quantities, which causes wide range fluctuation in stock prices.

Risk of Stock Exchange restrictions

Since penny stocks are issued by ultra-small companies, their compliance with the law and the stock market regulations may be casual. This usually attracts adverse regulatory action from the stock exchanges. They can impose upper and lower circuits on the companies to prevent excessive speculation in them. The imposition of a circuit adversely impacts the ability of the trader to exit the stock when he wants to. If the company continues to de-comply with regulatory laws and rules, The Securities and Exchange Board of India (SEBI) has the power to order such companies to delist from the exchanges.

Four points to remember before investing in penny stocks 

Before you invest in penny stocks, keep these four things in mind.      This will ensure that you don’t just invest because the stock is cheap but because it is fundamentally strong.

1. Draw a line

Don’t invest all your savings in penny stocks. Set a very small portion aside and don’t let this investment exceed 2-3% of your portfolio value.

2. Diversify your portfolio

You must diversify your portfolio by investing in other investment options as well. Spread your investment amount across two to four penny stocks. Also, balance your investment portfolio with less risky and fundamentally strong stocks. There is only one downside of this strategy. If one stock performs phenomenally and delivers huge returns, the impact on your portfolio will be relatively less.

3. Regularly monitor the performance

Being highly volatile and risky in nature, one must not buy and forget about penny stocks. Watch the price movements carefully. You must be proactive when dealing with penny stocks.

4. Don’t trust the data blindly 

Penny stocks can be very easily manipulated. Hence always be suspicious of the reports you read. Do not be gullible or get lured by rosy pictures that the operators might be projecting. Dig for extra information on news portals, press releases, etc.

List of stocks trading below Rs. 10 in India

More than 900 stocks are trading below Rs. 10 on Indian stock exchanges. Of course, the majority of these stocks might not be worth investing. So how to decide which penny stock to invest in? Watch this video by Mr. Kedar Kailaje where he shares an exclusive case study discussing how a penny stock worth Rs.1 became a multi bagger. To know which company he is talking about and how to find such outstanding growth opportunities, watch the video now. Watch: How a Penny Stock Became a Multibagger | Stock Market Case Study

Brokerage while trading penny stocks

Traders and investors in penny stocks must be careful of the amount of brokerage that they pay which can really eat into their profits. A large number of full-service brokers in India follow a practice of minimum brokerage per share. For instance, if you trade a stock of Rs. 5, then instead of your normal brokerage slab of 0.5% on delivery trades, you would be charged a minimum per share brokerage slab of let’s say Rs. 0.05 per share. Usually at 0.5%, your brokerage per share would work out to Rs. 0.025 per share but because of      minimum per share brokerage, the brokerage applicable would be Rs. 0.05 per share. So, let’s say you bought 10,000 shares of Rs. 5, your brokerage would be Rs. 500 (i.e., 10000 shares * 0.05 per share) instead of the usual brokerage of Rs. 250 on total turnover. Whereas in case of discount brokers, there is a fixed brokerage applicable like Rs. 20 or less. It never goes beyond the fixed brokerage as levied by the broker. So, while trading penny stocks with Samco, the applicable brokerage is Rs. 20 per executed order or 0.2%, whichever is lower. So, in the above example, the brokerage applicable would only be Rs. 20 and not Rs. 500.

End Note: 

Before buying penny stocks, doing your homework is crucial. Don’t be dependent on tips and recommendations. You might have read many success stories of investing in penny stocks and building a fortune. But what they don’t tell you is that not everyone is able to find such multi-baggers. Penny stocks are high risk trades. Don’t make the mistake of committing a large portion of your investment portfolio to it. Invest smartly and responsibly. Allot a small portion of your portfolio to the best penny stocks in India. To save your time, we have curated a list of best penny stocks to buy right now listed in India. Open a FREE Demat account with Samco, the best discount broker in India and start your investment journey today!