Penny stocks fail to give wing to dreams with poor 2016 show

It is the dream of every investor to buy a multi-bagger stock that helps him realise all his dreams. But going about this by buying penny stocks — stocks trading at a price of less than ₹1 — is fraught with risks.

Penny stocks have had a poor run in 2016. Only three out of every 10 such stocks have delivered positive returns to investors in the period between January and August.

There are around 130 penny stocks trading on the BSE; almost half of these stocks are down more than 20 per cent so far this year. Some stocks, such as Solid Carbide, Uttam Value Steels and Pasari Spinning, have taken a sharper hit and are down more than 70 per cent since January.

Many of these stocks have been beaten down to these levels because their financial performance has deteriorated significantly, their businesses are in trouble or because of governance-related issues.

Half the companies whose stock price is less than ₹1 have revenue of less than ₹1 crore. This raises serious doubts about their business viability.

Two-thirds of the penny stocks are making losses and the others make negligible profits. The losses of some companies, such as REI Agro and Nakoda, are over ₹100 crore.

Consistent losses have resulted in eroding assets, resulting in a negative net worth for many of these companies. Two-thirds of them have an ROE ratio of less than 1 (the Return on Equity ratio shows the efficiency of the company in deploying shareholder capital).

A low level of disclosures combined with governance problems also increases risks manifold. For instance Jai Mata Glass (stock price ₹0.19), a manufacturer of frosted glass, has not reported any revenue over the last couple of years.

The company’s net worth is negative and very little information is available in the public domain about its current business or its prospects.

Similarly Cals Refineries (₹0.08) proposed to set up a refinery of approximately 10 MMTPA in West Bengal to emerge as the third largest oil refining and petrochemical company in the private sector. But the company has almost no operations currently.

Cals Refineries was investigated by the Securities and Exchange Board of India in relation to its GDR issue and the company has been barred from tapping the security market for a certain period. This is reported to have derailed operations.

Another penny stock, Winsome Diamonds and Jewellery (₹0.45), features prominently in the wilful defaulters’ list and owes banks and financial institutions more than ₹2,000 crore.

While the performance in 2016 has been quite tepid, penny stocks have done quite well in the period between January 2014 and now.

All the 147 stocks that traded below ₹1 in January 2014 have delivered gains to investors, with an average gain of 264 per cent.

Almost 60 per cent of the stocks managed to double their price and a third of the stocks have given more than two-fold returns.

This good run could be due to the Modi rally in 2014, which lifted all the stocks as a surge of optimism engulfed the market. The top gainer in this period was Smiths & Founders, manufacturer of castings, forgings and machined components.

The stock rose from₹0.32 to ₹14.5, delivering 45-fold returns. Ducon Tech was a close second, rising from ₹0.35 to ₹14.28 since January 2014.

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