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Is this a Good Time to Buy Penny Stocks?

May 10, 2022

Now, Exponential Profits hasn't had a single recommendation closed at a loss for more than 2 years now.

Yes, that's right.

We've closed 28 penny stock recommendations since January 2020 and every single one of them at a profit.

The gains have ranged from as low as 22% in 11 months to as high as 177% in one year.

How much of this is luck and how much can be down to skill?

Did we really get lucky in Exponential Profits or was there some process we followed to deliver consistently good returns over the long term?

Well, I would say it is a mix of both. But to be honest, it was more skill or process that led to this outcome than just luck.

For example, back in March 2020 when the index cratered close to 40%, the Exponential Profits corpus was sitting on cash of 70%.

Yes, we had as much as 70% of the corpus parked in FDs. That the market crashed 40% in a few days was of course luck. But our 70% allocation to FDs wasn't. It was a part of a well thought action plan and strategy.

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You see, there are good times to invest in penny stocks and there are bad times.

If you happen to invest in them at a good time, then even an average looking penny stock can end up giving you multibagger returns.

Consider stocks like Precision Camshafts, Tamilnadu Petroproducts, NCC, KCP Sugar, and NBCC. These penny stocks can be considered average at best. None of them are tom-tommed by analysts or hit the headlines on a regular basis.

Yet, they gave returns of 177%, 175%, 170%, 130%, and 109% respectively, with an average holding period of less than a year.

The reason they ended up performing so well was because I recommended them at the right time.

You see, a good time to invest in penny stocks is not when the entire world is going ga-ga over them. In fact, it's when people are fearful and don't like to go anywhere near them.

This was certainly the case back in March 2020. People feared taking exposure in even bluechips let alone penny stocks.

But we saw this as one of the best opportunities in years.

Investors were right in being wary of penny stocks with high leverage and in weak competitive positions. But fear regarding a fundamentally decent penny stocks trading at extremely attractive valuations made no sense to us.

We knew most of these penny stocks have been around for years and had the potential to survive a couple of tough years.

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Therefore, all we had to do was wait and we were confident the returns would come.

Luck did play its role in that the turnaround came faster than expected. All our recommendations made during that period did well and we were able to close all of them at a profit.

You see, there are two important elements to investing successfully in penny stocks.

The first involves knowing when to turn aggressive and when to turn defensive based on the overall market valuation.

When the broader markets are cheap like they were in March 2020, one should have at least 70%-75% of the corpus in penny stocks. When they turn expensive like they were just before the Coronavirus crash, one should reduce exposure to penny stocks to only 25%-30%.

Most investors approach the markets without any concrete strategy. They end up doing the exact opposite. They will get interested in penny stocks only after the market has gone up a great deal and become disillusioned with them after a big fall.

This way lies sorrow in my opinion. The best time to invest in penny stocks is when the stock market is on sale, not when it's irrationally exuberant.

The second important element is the type of penny stocks to buy.

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Here again, the consensus has it wrong. Most penny stock investors invest in turnaround penny stocks that have had a terrible few years but are now on the brink of recovery. Or they chase high growth penny stocks that can become huge multibaggers over the next 2-3 years.

The problem with the first category is that turnarounds seldom turn. One is better off devoting the same energy to finding a fundamentally strong penny stocks trading at attractive valuations.

The second approach is also fraught with risks. High growth penny stocks are mostly available at premium valuations.

Besides, if the growth slows down for few quarters, the stock price can come crashing down, leading to huge losses.

My favourite category of penny stocks are those where the stock is neither a turnaround candidate nor a high growth stock.

Instead, it's an above average business that's available at below average valuations.

These stocks may not be growing very fast but are not in poor shape either. Thus, by buying them at extremely attractive valuations, one can minimise the downside and at the same time, ensure a good upside.

The 5 stocks that I mentioned earlier i.e. Precision Camshafts, Tamilnadu Petroproducts, NCC, KCP Sugar, and NBCC, all fall in this category.

They may not be growing their profits fast but they are good businesses. However, there are times when Mr Market prices them as if these businesses are going to go bankrupt.

This is when we should jump in and seize the opportunity.

Yes, some of them may fail to give good returns over the next 1-2 years. But if you have got your stock selection right, a good number of them will give great returns, leading to a great overall result.

So here the two essential elements again...

  • Know when to be aggressive and when to be defensive.
  • Ignore the fundamentally weak as well as the exorbitantly priced penny stocks.

Follow these two principles and I'm sure you won't get a poor result from your penny stock investments. Subscribers to Exponential Profits certainly done well. The results have been very good.

Warm regards,

Rahul Shah
Editor and Research Analyst, Profit Hunter

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