Penny Stock Master Series: The Gains Keep Rolling

Feb 13, 2021

Rahul Shah, Editor, Profit Hunter

Welcome to the second of the 3-part master series where I am on a quest to go back in time and multiply my money by 10X by investing in penny stocks.

If you haven't read the first part yet, I recommend you do so by clicking here.

As we saw, the first five year period of our quest was nothing less than a dream run. The portfolio went up by 4x, logging in a CAGR of more than 30%.

These returns are worth their weight in gold in any market environment. But the fact that they were achieved in a stock market that went up by less than 30% is even more creditable.

More than anything it proved that my penny stock blueprint is capable of doing well even in a sideways market.

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What about a bull market? Can the strategy do equally well in a rising stock market where stocks all around are witnessing a buying frenzy?

Well, we didn't have to wait too long to get an answer to this question. The year 2016 and 2017 were exactly such years for the stock market.

The Sensex climbed at a rate of 14% during this two year period, a far cry from the 5% CAGR it witnessed between 2011 and 2015. However, the real big gains came in the BSE Small Cap index which surged 62% point to point or a CAGR of 27%.

Was our penny stock portfolio up to the task? Of course, it was. It not just performed well but ended up knocking the daylights out of the benchmark indices again.

The penny stock portfolio was up a massive 3x in a matter of 2 years, thus improving the overall gains from 4x in the first 5 years to an impressive 12x in 7 years.

Well, we had the goal of multiplying our money by 10X in 10 years. But courtesy the bull run of 2016 and 2017, our goal was accomplished in 7 years flat. I believe that's a phenomenal performance whichever way you look at it. The penny stock juggernaut just rolled on.

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Here are a few penny stocks that helped us achieve the phenomenal results in 2016 and 2017.

  • Bhageria Industries, up 432% in 12 months in 2016
  • Gujarat Ambuja Exports, up 88% in 12 months in 2016
  • SORIL Infra Resources, up 182% in 12 months in 2016
  • Tamilnadu Petro Products, up 207% in 12 months in 2017
  • Saurashtra Cements, up 54% in 12 months in 2017

Important Note: Worth pointing out that since the markets were up substantially both in 2016 and 2017, only about 6-7 penny stocks were able to clear our strict buying criteria during both the years. While we decided to go ahead and use only these names, one can expand the universe by loosening the valuation criteria or the balance sheet criteria. We don't think the results would be a lot different than this.

I see two big reasons behind why we were up a massive 12x in 7 years when the broader market was up just 70%.

Number one is the stock selection criteria. We did not go after popularity or dabbled in highly speculative stocks.

We insisted on hard core value investing principles where we asked for big, fat margin of safety in valuations and a business of a decent quality if not the best. Because these were good businesses and were bought at extremely attractive valuations, any good news made them go up like a rocket. These were businesses that were going through temporary hiccups where all the bad news was already priced in.

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Of course, not all of them worked out the way we expected them to. But the winners more than made up for the losers and the net result is what we have in front of us.

I think the single biggest mistake people make while investing in penny stocks is that they either chase momentum i.e. popularity or end up investing in highly speculative businesses. And while they may get the odd success here, the end result is always a big disaster. After all, there is no point in multiplying a long string of positive numbers if the last number in the string is a zero.

By insisting that a penny stock have safeguards in terms of valuation and business quality, we are trying to avoid the big zero towards the end.

Another big reason why the portfolio was up so much is that we did not encounter a single bear market of the kind we witnessed in 2008 or even back in March 2020.

The big test of a strategy is when it encounters a market that's down 40%-50% from the top. This is when its mettle gets tested. And since we did not encounter a market of that kind during the entire 7-year period, the portfolio ended up doing really well.

Having said that, the real test of the portfolio lies ahead.

We are going to enter an extremely brutal period for mid and small caps, a period nothing less than a bloodbath. Yes, we are now at the doorstep of the worst period for mid and small caps in recent history.

It will be interesting to see how the portfolio protects itself in such an environment. Will it give up most of the gains it has managed to achieve during the first seven year period? Or is there some trick up its sleeve?

We will talk about it and more in the concluding part of this master series i.e. tomorrow.

Do watch out for it.

By the way, if you haven't registered for my Monday webinar where I will talk about my strategy in more detail, you can do so by clicking here.

Good Investing,

Rahul Shah
Rahul Shah
Editor, Profit Hunter
Equitymaster Agora Research Private Limited (Research Analyst)

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