Indian Penny Stocks: Understanding the Landscape

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Indian Penny Stocks: Understanding the Landscape

Dec 15, 2021

Indian Penny Stocks: Understanding the Landscape

Penny stocks are stocks which are of lower denomination in terms of stock price. They are often mistaken to be 'cheaper' than higher priced stocks, which may not be the case.

There's a definition of penny stock in the US i.e. stocks that trade for less than US$5 per share. But there's no such classification in the Indian context.

Many refer to stocks trading below Rs 50 as penny stocks. Others consider stocks which have less than Rs 100 share price. Some also consider stocks below Rs 10.

Let's take a look at the total number of penny stocks present in the Indian stock market as of 14th December 2021.

Number of stocks trading at or below Rs 100

From the total listed companies, the number of stocks which are active and trading below or at Rs 100 as on 14 December 2021 are 844.

Of course, this number might change every day as stock prices move up or down.

Out of the 844, the top two spots in terms of marketcap are held by IDBI Bank and Bank of Baroda.

The list is followed by Vodafone Idea, PNB, and Indian Overseas Bank.

Number of stocks trading below or at Rs 50

The total number of stocks trading below or at Rs 50 as on 14 December 2021 are 605.

The top three spots in terms of marketcap are held by Vodafone Idea, PNB and Indian Overseas Bank. They are followed by Yes Bank, Union Bank of India, and NHPC.

Out of 605, 420 stocks trade below Rs 25.

Number of stocks trading below or at Rs 10

As of 14 December 2021, there are only 230 stocks which trade at or below Rs 10.

Here, the top spots in terms of marketcap is held by Suzlon Energy and Jaiprakash Power Ventures. These are followed by RattanIndia Power, GTL Infra, and The South Indian Bank.

Should you buy penny stocks for investment or speculation?

The answer's pretty clear, right?

It goes without saying that you should buy penny stocks from an investment perspective.

What if the penny stock under consideration is a high growth company and promises to make big profits in the future?

Even then, your perception should be of investment and not speculation.

Not just penny stocks, the first and foremost rule in investing of any kind is that your principal amount should be safe. There should be a minimum risk of downside.

Benjamin Graham placed vital importance on this concept. In fact, he begins his book The Intelligent Investor with this subject.

In his own words:

  • 'An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative'.

So, before investing in penny stocks, a thorough analysis of the facts and fundamentals are highly recommended so that your investment will be protected from a loss under most conditions.

Investing legend Warren Buffett was once asked this curious question in an interview: 'Isn't speculating and investing all the same'?

'Most definitely not' came the reply.

Since speculation is common in penny stocks, many investors are lured to them due to this reason.

If you are placing a speculative bet (even though it's not advisable), you should have a strong definitive reason to back it.

This is because speculation is not for the faint hearted...your entire capital may get eroded.

Should you buy growth penny stocks or value penny stocks?

Let's go one by one.

Growth stocks are those which grow sales and profitability at a faster rate than market average.

On the other hand, value stocks are those which offer value at their current price, i.e. they are undervalued.

Although value investing has been around a long time, several analysts are arguing that it's dying. The world is now a different place with internet companies offering growth taking over.

An article from The Hindu back in 2019 stated that value stocks have done better historically. It argued that over the past 19 years, the MSCI India value index has done better.

Does this mean that value stocks lag all the time? No. The article further argues that in a bull market, growth stocks overtake value stocks.

However, value stocks tend to contain losses better than growth stocks in bear markets. Therefore, if there is a strong correction in the market, you would want to be in value stocks.

It's confusing to pick between the two, isn't it? This is because both have their pros and cons.

But there's a solution.

You can take exposure to both value as well as growth penny stocks and then keep changing the allocation based on relative underperformance and outperformance.

Another option would be to ignore this classification completely and go with Warren Buffett on this topic.

Here's what Buffett once said about growth and value stocks:

  • 'Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive'.

So rather than segregating stocks based on growth and value, consider growth as a component of value always and not a separate entity.

How much should you allocate towards your penny stock portfolio?

Penny stocks are inherently riskier than bluechip or midcap stocks.

On the brighter side, they present a huge growth potential. It's not unusual for a good penny stock to turn into a multibagger in a matter of months.

On the flipside, there is a high risk attached to them. Not all penny stocks tend to be outperformers. In fact, there are instances where penny stocks have plunged 80-90% when things turned sour.

That is the reason penny stocks are not recommended to those having a low risk profile.

If you have an appetite for slightly more risk, it's recommended that not more than 5%-7% of one's portfolio be invested in penny stocks.

This means that the corpus that one sets aside for penny stocks should not be more than 5%-7% of the total money allocated towards equities.

What is the right penny stocks strategy?

Hoping to make quick and big bucks, investors are often lured into penny stocks.

But little do they know that with low liquidity and limited information, penny stocks are among the riskiest investments around.

While some penny stocks may rise decently in value, many of them never see profits.

Since all investing comes with risk, diversifying your portfolio with penny stocks is a good strategy. Simply chasing the safest bluechips is only going to offer one thing: low returns.

And that's where penny stocks come in.

But here's the crux. There are around 1,000 penny stocks that are vying for our attention.

If you don't know how to say no to more than 90% of them, you will end up with a lot of junk.

To separate the men from the boys in the penny stock universe, you need a strong framework.

A framework that not only enables you to zero in on the right penny stock at the right price but also helps you avoid those big losers.

Luckily, Co-head of Research at Equitymaster has once such framework ready in place. It goes by the name 'The S.O.L.I.D Framework'.

In a nutshell, here's what the different components of SOLID stand for:

S - Strong Balance Sheet

O - Owner Operators

L - Long term Business Viability

I - Income Generating

D - Deeply Discounted Valuations

This framework eliminates most of the junk penny stocks and lets through only the most fundamentally strong and the most attractively valued penny stocks.

Believe me when I say that you need this framework especially if you're just a beginner and trying to steadily grow your wealth.

Since we're talking about penny stocks, don't forget to watch Rahul Shah's video where he shares an effective technique to pick out the right penny stocks.

Happy Penny Stocks Investing!

Here are Links to Some Very Insightful Equitymaster Articles and Videos on Penny Stocks:

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...

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