What are penny stocks?

Low-Priced and mostly illiquid stocks of the company whose market capitalization is very low are called penny stocks. In India, they can have prices less than Rs. 10. Penny stocks are considered highly speculative and risky due to their lack of liquidity, less information disclosure, and less number of shareholders. Due to the risks associated with it, exchanges have put penny stocks into the trade-to-trade basket. This category of shares are not allowed to trade intraday.

However, some of these stocks also carry with them the potential of turning investments into a fortune.
For example, you buy 10000 shares of a penny stock at Rs. 5 and thus make an investment worth Rs. 50000. An increase of just Rs. 1 can give you a 20% return. This prospect looks interesting
But again, as you guessed it, you run the risk of losing 20% of your capital if the price goes down by just Rs. 1.

Should you invest in penny stocks?

Investing in penny stocks is attractive when you look at its potential. But an investor must look at both sides of the coins before making his decision.

Benefits:

Opportunity to reap huge benefits

Right penny stocks often can turn into a multi-bagger. Sometimes stocks of some companies are affected due to certain events so highly that the prices drop significantly. These companies do not have broken fundamentals, but the broken stock price. Investing in such companies can be a good idea, provided the investor is familiar with the company’s financials.

Companies like Titan, Kotak Mahindra Bank, and Lupin whose trading price was once lower than Rs. 5 have proven that some penny stocks are worth investing. Now, these stocks are trading at prices more than 100-200 times of what they were 15-20 years back.

Low Investments, Big Profits

Since penny stocks are priced at less than Rs. 10, an investor can buy a large number of shares for a small amount. Any increase in price can bring the investor huge profits in a short period. An increase in the share price of Vodafone-Idea from Rs. 3.5 to Rs. 10.5 within 1 month is such an example.

Risks associated

Prone to Price Manipulation

Penny stocks are the ones that are prone to the most price manipulation. Due to the low pricing, any institution or individual investor can increase the price of the stock by buying in a lot of quantity and cause the price to increase. The average investor is hardly left with any knowledge if the rally was authentic or manipulated. This increases the risk of buying such stocks.

More Prone to Scams

Since it is easier to manipulate the pricing of the penny stocks, there always remains a looming threat of scams involving the stock. Low pricing is like adding a feather to the hat. During the infamous Harshad Mehta Scam, the price of ACC Cements share rose from Rs.200 to Rs. 9000 within a year. This price manipulation was as a result of diverting crores of money from the bank to the stockbrokers.

Thus, it is always advisable to be very cautious while investing in stocks, much more so in penny stocks. If chosen right, they can turn your investment into a fortune. But one wrong choice can leave you penniless!