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Sometime ago, I found that the stock of JP Associates was trading around Rs.6. It was a attractive pricing but I took some time to understand the fundamentals and identify the reasons behind the low pricing.
On fundamental terms, the stock had a P/B of Rs.60 but the company was in a debt trap. JP Associates is a renowned name with constructions as big as the Buddh International Circuit and the Yamuna Expressway. So, the management had a good reputation. I felt that, JP could sell some assets and reduce the debt. In that case, even if the P/B came down to Rs.30, the stock was undervalued. So, I made some investments. My reading turned out to be correct. JP Associates and Ultratech struck a deal and the stock price soared.
Investing in Penny Stocks is not always a good gamble. Sometimes, the low prices reflect that the company is in doldrums and will see more trouble. In such cases, one cannot identify the bottom and the price keeps going lower. In the more fortunate cases, investors get high returns like in case of Satyam. Sometimes, even the returns are so high that even Blue Chips cannot yield such returns. They are not the ideal choice for the safe investors but the risky trader likes these stocks.
Typically, stocks that trade below Rs. 10 are classified as penny stocks. Most of these stocks are under the trade-to-trade category for avoiding speculative activities.
There are risks associated with these stocks. There are possibilities of price manipulation as low prices make it possible to move prices with small investments. Once the manipulation is over, big player exit the stock while the retail remains trapped. Soon the stock prices crashes leading to losses.
There is also lack of information on penny stocks. Brokerages generally do not publish research reports on penny stocks. Sometimes, manipulations spread rumours and rig prices. It has also been found that the underlying companies often violate the exchange rules. Many a times trading gets suspended from these stocks. In such scenarios, the retail investors suffer.
On the positive side, a penny stock can become a multi-bagger if the company turns positive. Such a scope is less for a high priced stock even if the prospects are bright. New investor can take a gamble on these stocks by investing small amounts.
Investment in penny stocks can be done by considering certain factors. The fundamentals of the underlying company like promoter holding, corporate governance, business potential and management outlook should be studied. The trading volume should also be studied because low volumes often make it difficult to exit the stocks.
One of best possibilities of making a big buck out of penny stocks is to buy stocks that have a long terms story in them. As time goes on, the stock prices appreciate and the investment becomes multi-bagger.
Penny stocks are not the ideal choice for speculative trading. Although the stock may give some returns but the beauty of investment in penny stocks can only be realized through long term opportunities.