The Hindu Business Line : Watch your pennies... They may go any where

GSLOT Entertainment, My Fellow Fashions, Women Networks and Simran Farms ... With imaginative names, outlandish returns and wildly gyrating prices, penny stocks are a parallel world of stock market investing; that is, if you can call this "investing".

It is a market where a stock that climbs by 5 per cent in a day is a laggard, where the quarterly earnings season can come and go unnoticed, and where trading volumes are more important than balance-sheets.

Piggybacking the bulls

Penny stocks have managed a stunning rise in market capitalisation over the past year, attracting hordes of speculators, informed investors and unsuspecting novices. One telling statistic (refer Taking Count on Page 6) is that if you bought into the entire universe of small-cap stocks trading at Rs 5 or less in September 2004, you would have logged a whopping 350 per cent return by now. And lower the absolute price, higher appears to be the return. Stocks trading at less than Rs 2 have managed to appreciate by 500 per cent over the same period!

To a novice, buying into penny stocks would appear to be money for jam. You simply buy into a stock that is trading at less than Rs 5, on a tip about a "really huge order" from somebody who calls himself a "stock guru" on an Internet message board. You wait till the stock it hits the magical "target price" helpfully supplied to you by your mentor. When it rises tenfold within a month to hit that target price, you sell out, and head to the bank, with a tidy sum in the pocket. Needless to say, no bothering to understand the company's business or dissect its quarterly number. Anyway, in many cases, the company may have neither!

Of splits and name changes

Sometimes, the company that your penny stock represents will also oblige you by splitting its stock to make it even more affordable. A spate of small companies, which have not made a corporate announcement in years, have split their stock in recent months to bring their stock price down from, say, a steep Rs 20 to an affordable Rs 2. The face value of a penny stock does not matter in this bull market; all you need is for the absolute price of the stock to be less than Rs 10.

IQMS Software was trading at Rs 7, when a 10-for-1 split in the stock took effect. The stock listed at 62 paise post-split, only to zoom to Rs 2.60 within a few weeks as volumes went through the roof. Stock-splits that take the price of a stock to less than Rs 10 have inevitably transformed penny stocks into multi-baggers over the past few months.

Name changes also seem to work magic on penny stock prices. A "Koffee Break Pictures" may attract market fancy, while it was ignored as My Fellow Fashions. Landmarc Leisure, with its suggestion of entertainment, may have investors flooding the market with buy orders, though the same stock languished as S. Kumar's Infrastructure for quite a while.

Dos and don'ts in penny stocks

Investing in penny stocks has been such a popular pastime the world over, that the US' Securities Exchange Commission has an official definition for "penny" stocks — broadly, stocks that trade for under $5. There are markets and exchanges in the US, such as the OTC Bulletin Board of the Nasdaq or the National Quotation Bureau's popular "Pink Sheets", devoted to penny stocks. You can also hone your skills on penny stock investing through a dozen or so serious Web sites such as — www.pennystocks.com, www.peterleeds.com, or www.allstocks.com — that set out in detail the dos and don'ts of penny stock investing.

From here, we glean a few rules on penny stock investing and add a few from the Indian experience, as we go along:

Hold only a fraction of your portfolio in penny stocks and do not give in to the temptation of buying too many shares in the hope of making big money;

Do not act on any advice that comes free;

Do not buy stocks of companies that have defaulted on their listing agreements (stocks from the Z Group);

Book profits when the stock is on an uptrend. Don't regret it if you have left 40-50 per cent of the returns on the table.

Trading volumes are everything in penny stocks. Book profits on the first sign of waning volumes.

Risks with a capital `R'

We do not recommend that anyone should "invest" in penny stocks to create wealth. Betting on these stocks really has nothing to do with stock market investing. It can be a thrilling experience and may even multiply your money; but that is about all. And do not expect the regulator to come to your aid if a penny stock tanks. You went into it with eyes wide open.

If you invest in penny stocks, you have to be prepared to:

watch your stock swing by up to 20 per cent either way on a single day;

see your entire investment being wiped out overnight, as investors desert your stock to hop on to another money-spinner;

watch trading volumes dry up from a few lakh shares to few tens, overnight, leaving you holding worthless paper.

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