Busting the Investing Myth that Penny Stocks Can Lead to Marvellous Riches


“What you’ll find is that little acorns can grow into giant oaks, and that with persistence and hard work, anything is possible.” – William J. O’Neil, MarketSmith Founder.

In recent days, MarketSmith India has been highlighting some investing myths that need to be debunked.

These include the idea of buying a stock with its price on the way down, so that your average cost goes lower, and the notion that you can always make money by buying low, selling high.

Today, the myth that a growth investor should never fall for, is the false promise of riches from penny shares.

You have probably received at least one email that read something like: ‘Invest now in Acme Gadgets While you can still get it for INR 12, the stock looks set to Explode … Small Fortunes could be made by those who get in now!!!’

The idea of making big returns on what seems like a sure bet can be tempting. And people sometimes do get lucky buying the so-called penny stocks.

But, the purchase of such stocks carries with it an unusual amount of risk. For this reason, MarketSmith India focuses on high-quality, more expensive stocks that are priced at least INR 20 a share and have a 50-day average trading volume of at least INR 60 lakhs.

Though the potential of making good returns is high with penny shares, the risk of losing it all is even higher. There are high chances of price manipulation as few investors hold majority stakes in the company due to its low market cap.

The penny stocks are extra-risky because they’re volatile; a handful of investors trading even a small block of shares can send its prices swinging wildly. Institutional investors tend to avoid such stocks because it is hard to build and exit substantial positions when only a few shares are traded.

The big funds have crores of rupees to invest. So, they naturally prefer more liquid stocks, and build positions over time. This lends an element of stability and predictability to a stock’s price movement.

When picking socks, preference should be given to companies with strong business growth story and at the price they are trading. The growth and evolution of a company’s business builds the value of the stock. Price of the stock may garner temporary demand for a stock but it cannot sustain returns over a long period of time.

Understanding stock markets, employing strict trading and persistent learning will help grow investments and not just low priced stocks.

Note that the average price of stocks in the IND 47, or our Model Portfolio, is high. Most have buy points that are in the range of INR 100 or higher, and in many cases, much higher. On November 14, 2013, Page Industries broke out above a 4,957 buy point; in 104 weeks, the manufacturer and distributor of Jockey branded innerwear and leisurewear rallied 152% to reach a peak of 12,493 on November 11, 2015, building a new base before going into correction mode.

Stocks such as Page industries that sell for high prices and enjoy strong institutional sponsorship have an added benefit: They’re much less vulnerable to ‘pump-and-dump’ or ‘boiler room’ scams.

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