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How to Invest in Penny Stocks

Penny stocks are shares of listed companies with low market capitalisation. These stocks usually have low share prices, typically less than Rs 100 and often less than Rs 50.

Well-chosen fundamentally strong penny stocks have the potential to deliver profits greater than 1,000% within 1-3 years. This is almost impossible in the case of largecaps.

This is the main reason for their popularity.

On the flipside, there is a high risk attached. It’s common to see penny stocks plunge 80-90% when things turn sour.

Even if you have a high risk profile, we recommend not more than 5% of the portfolio be invested in penny stocks.

You can start you’re search with Equitymaster’s stock screener to find the best multibagger penny stocks. The screener allows you to screen stocks based on your own criteria.

Look for these qualities...

  • Strong balance sheet: Look for low debt, high cash balance, & a current ratio greater than 1 i.e. current assets greater than current liabilities. Equitymaster’s stock screener can help you find debt free companies.
  • High promoter holding: The higher the better. It shows the promoter has skin in the game. Promoters buying shares from the market is a good sign. Use Equitymaster’s stock screener to find stocks where promoters are increasing stake.

Avoid companies with promoter pledging. Equitymaster’s stock screener has you covered - Stocks with high promoter pledging.

  • Quality of the business: Ask these questions. Is it a good business? Are the fundamentals strong? Will it be around after a few years? Is it making profits? Use Equitymaster’s stock screener to find profit making penny stocks.
  • Cash flows: Does the business generate cash from its operations? If yes, then is it growing? How is the cash being used?
  • Cheap valuations: It’s always a good idea to buy penny stocks when they are cheap. Check if the stock is trading below its book value. A margin of safety of at least 20% below book value is a good entry point.

This framework will not only enable you to zero in on the right penny stock at the right price but also help you avoid the big losers.


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