Ten Common Investment Strategies and Why They May Not Work - Business Today

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Ten common investment strategies and why

they may not work
Shoaib Zaman and Rahul Oberoi April 14, 2014
How many times have you been told about 'the next big stock' by a broker, a friend or a
colleague? The stock, you are told, has all the makings of the next blockbuster.
The argument is persuasive, either in the form of anecdotes or backed by data. Maybe an
investment guru has made millions on the stock. Or, there is a chart showing the stock's
past returns or, maybe, a study listing reasons why it will bring you enormous riches.
However, once you invest, the stock stops performing, or begins well and then starts to
falter. You are disappointed and decide never to invest in any stock.
If this sounds familiar, take heart, for you have company. Aswath Damodaran, Professor at
New York University, in his book 'Investment Fables,' captures the essence of these
stories. "While there are hundreds of schemes to beat the market, they all are variants
of about a dozen basic themes that have been around for as long as there have been
stocks to buy and sell. These broad themes are modified, given new names and marketed
as new strategies," says Damodaran.
We identify some of these strategies that appeal to stock investors and see if they are
workable or, as Damodaran says, just fables.
MYTH: BUYING DIVIDEND-PAYING COMPANIES IS AS SAFE AS INVESTING IN
DEBT. AND A COMPANY THAT HAS ANNOUNCED THAT IT WILL PAY HIGH
DIVIDEND THIS YEAR IS A GOOD BET.
Reality: Investors with little risk appetite prefer the safety of government bonds or bank
fixed deposits rather than stocks. The belief is that these are risk-free. Such investors are
told that a dividend-giving stock offers safety, regular income, plus scope for capital
appreciation. But what is not mentioned is that dividend payments can never be predicted,
a big minus for any investor looking for regular income.
Take Bajaj Finance. Its stock went up from Rs 400 on 2 January 2006 to Rs 1,318 on 31
December 2012. The company paid dividend in each of these six years. In 2005-06, it
paid Rs 4 per share. In 2008-09, it paid just Rs 2. Some say this is because 2008-09 was
a year of economic crisis. But this argument does not hold much water as out of nearly
4,000 companies listed on the Bombay Stock Exchange, or BSE, 662 have paid dividend
every year for the last 10 years. One of them is Bajaj Finance. Of these, 100 have been
increasing the payout or maintaining it at the previous year's level.
Vikas Gupta, executive vice president, Alpha L50 (India), Arthveda Fund Management,
says US pension funds and investment trusts used to invest in only top dividend-paying
companies. This forced big companies, especially the market leaders, to pay dividends
regularly so that they could qualify for investment from these big investors. Some even
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borrowed money to pay dividends.
But in India the story is different. "Here, the dividend yield of the highest dividend payers is
approximately half the risk-free rate. Therefore, it is not possible to implement the strategy
in entirety," says Gupta. Dividend yield shows how much a company pays in dividends
each year relative to its stock price.
But if you still want to go for high dividend payers, you must ask the following
questions. How consistently has the company been paying dividends? Is the industry
cyclical and has the company been paying dividends during tough times as well? And, of
course, how does it get the money to pay dividends regularly?
Dipen Shah, who heads private client group research at Kotak Securities, says investors
must never lose sight of the company's fundamentals while choosing a stock. "One should
look at data for the last three years to see if the company has been paying dividends," he
says.
Rupesh Patel, fund manager, Tata Asset
Management, says three types of
companies pay high dividends. First, those
which have strong business models and a
lot of free cash flow. Second, those which
have spare cash to pay investors even
after investing for future growth. Third,
those which have don't have many
avenues to invest for growth. The third
category is problematic, say experts, as it
doesn't give investors the advantage of
fast growth.
But there are many who vouch for the
safety of companies that pay high
dividends. Anindya Bera, a retail investor
from Kolkata, says, "I prefer safety over
risk. High dividend-yield companies are safer in an otherwise risky investment landscape.
Most tend to be mature companies with stable revenues. This gives comfort."
Kiran Kavikondala, director WealthRays, says, "We have been recommending stocks that
have a long history of earning dividends. But we stick to large companies in this category."
But Ayush Mittal, a resident of Lucknow, says it's not necessary to stick to large-cap
companies in the category. After rigorous research, he bought shares of Mayur Uniquoters
and MPS Ltd, which had a long record of paying dividends and strong earnings growth.
He made substantial profits. "Rather than looking at just the dividend percentage,
investors must look at the dividend payout percentage (of net profit) being distributed (a
good dividend payout for a manufacturing company is >25% of net profit)," he says. This
reinforces the view that focusing on research to find companies with strong fundamentals
is important.
"Our experience is that investors in the 45+ age group prefer public sector companies
over private sector ones," says Kavikondala of WealthRays.
"But there is no evidence that public sector companies pay higher dividends than the
private sector ones. Investors following the dividend strategy need not skew their portfolio
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towards public sector companies."
On which group of investors should not bet on dividend-earning stocks, Kavikondala says,
"If the aim is capital appreciation, this is perhaps not the best approach." Investors should
understand that the strategy may deliver lower returns in bull markets. This is because
investors focus on capital appreciation in bull markets and stability of earnings in bear
markets.
MYTH: FAST-GROWING COMPANIES WHOSE EARNINGS PER SHARE, OR EPS, IS
RISING BY 30% OR MORE A YEAR ARE GOOD INVESTMENTS AT ANY PRICE
LEVEL AS THEY WILL KEEP GROWING.
Reality: A present market leader would have been a fast-grower in early stages. There are
many ways to define a fast-growing company. The most common is looking at EPS,
revenue or sales growth. For retail investors, the best way is to look at the annual EPS
growth over the last five years.
When it comes to investing, there is a belief that one can pay any price for a fast-growing
company. For example, if an investor would have spotted Page Industries towards the end
of 2009, he would have found that its EPS had grown from Rs 5.41 (in 2004) to Rs 28.36,
a growth rate of 39% a year. The stock was at Rs 874 on 31 December 2009 and touched
Rs 5,878 on 28 February 2014; the EPS grew to Rs 100 during the period. At this stage,
the annual EPS growth rate for the last five years was 36%.
There are 21 companies that grew at more than 30% a year in 2006-11, 2007-12 and
2008-13.
All this sounds great. But the investor, who has the unenviable task of predicting the
future, should ask if this run can continue. Past growth, as we all know, may not always be
replicated. An excellent example of this is ICSA, whose EPS grew from Rs 0.15 in 2004 to
Rs 26.31 (growth of 191% a year). After that, the EPS started falling. In 2012 and 2013, it
reported negative EPS (- Rs 36.99 and - Rs 171.06, respectively). In the world of
investment, past performance tells little about the future.
"The pitfall of using this parameter is that one will end up looking at just revenue or
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earnings growth. A company can always boost its earnings by borrowing more and then
investing that money," says Gupta of Arthveda. He says a leveraged company not growing
according to plan is at a risk of defaulting on debt.
Hence, investors who want to follow this strategy should look at companies that are
growing fast but without taking on too much debt. It is best to look for companies that are
growing through internal accruals.
As Damodaran writes in Investment Fables: "If you put your money into companies with
highest earnings growth, you are playing the segment that is most likely to have an
exponential payoff or meltdown."
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MYTH: STOCKS TRADING AT LOW EARNINGS MULTIPLES ARE GOOD AS THEY
ARE BOTH CHEAP AND SAFE
Reality: Benjamin Graham is often named as the proponent of buying stocks trading at low
price-to-earnings, or PE, multiples. In his book, 'Security Analysis', Graham says that a PE
ratio of 16 "is as high a price as can be paid in an investment purchase in common stock."
On the lower side, he says, a PE of eight suggests that the market is not factoring in
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growth, making it a safe bet.
But what is often missed by those who follow the low P/E strategy is that Graham
suggested this as one of the parameters along with debt-to-equity ratio, price-to-book
value and market cap.
Among the BSE-listed 4,000 stocks, 239
were at PE ratios of between 8 and 16 on
February 28.
"The strategy based upon buying stocks
with low PE ratios is called value investing.
It is based on the assumption that shares
of comparable companies should trade at
almost the same PE multiples. If shares of
a company are trading at a lower PE than
that of others in the peer group, they are
considered undervalued. The aim of value
investing is to buy these shares and
expect that their prices will rise to levels at
what their peers are trading," says Yashpal
Gupta, executive vice president, IDBI
Capital.
But the real challenge is finding out the level at which you can call a stock cheap. For
instance, for a company in the fast moving consumer, or FMCG, sector, a PE of 20 is
considered reasonable. The reasons are stability of earnings and low debt. For the
opposite reasons, for an infrastructure company, the figure is 10.
"Therefore, one should always look at PEs of companies in the same industry, plus the
overall industry PE," says Patel of Tata AMC.
The effort should be to understand why the company is trading at a low PE ratio. The
reasons could be industry-specific or company-specific. If it is the latter, investors must
tread with caution.
Low PE is just an indicator. You should sift through low PE stocks and choose your
investments on the basis of fundamentals. However, some companies will always trade at
lower PE ratios while others will be valued higher because of the nature of their
businesses or management-related issues, etc. So, it is imperative to understand the
reason for the low PE ratio before investing.
Shah of Kotak Securities says, "If my view is that the market will remain subdued, I should
not be looking at low PE as the criteria. But when a sector is not doing badly but its stocks
are down due to negative news, I should look at low PE stocks."
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MYTH: MULTINATIONAL COMPANIES, OR MNCs, THAT ARE LIKELY TO DELIST
WILL PAY INVESTORS A GOOD PREMIUM OVER THE MARKET PRICE AND,
SECOND, MNCs HAVE HIGH GOVERNANCE STANDARDS AND LOOK AFTER THE
INTERESTS OF SHAREHOLDERS.
Reality: MNCs which have presence in India are highly regarded. But there are two types
of stories that investors must be cautious about.
The first is that MNCs will pay any price to buy back shares and delist from the Indian
market. This belief has taken hold ever since the Securities and Exchange Board of India,
or Sebi, the market regulator, said two years ago that all listed companies must ensure
that at least 25% shares are floating on the exchange.
Astrazeneca Pharma India shares rose after the Sebi announcement as the promoter
owned 90% of the company and the market expected that it would delist rather than
comply with the new shareholding norm. However, the stock fell 30% after the company
told the BSE that it will dilute promoter holding to 75% in a span of 45 days between
March and April 2013. "Using delisting as a strategy is speculation. One can only guess
when a company will delist," says Patel of Tata AMC.
Experts say delisting can at best work as a speculative strategy. There are other
strategies that one can employ while keeping MNCs as the base requirement.
"Investors can consider the buyback strategy as whether a company will delist or not is
something one can only guess," says Kavikondala of WealthRays. He says in a buyback,
one must look at whether the company has opportunities to expand. If not, one should see
if the management would like to reduce the number of shares in the market, as this would
raise the possibility of buyback. But amid all this, it's important not to forget the prospects
of the company. He says an aggressive investor can use this strategy but should not
commit more than 15-20% funds to it.
The second story often narrated to investors is that MNCs have high corporate
governance standards, strong brands, use capital efficiently and are in India for the long
term.
These factors seem to be working well for investors in MNCs. For instance, the CNX MNC
index, comprising 15 companies, has been outperforming the Nifty over the last few years.
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Deepak Ladha, executive director, Ladderup Corporate Advisory, says, "There are MNCs
which are not fast growing but pay regular dividends. Some do not give dividends but
grow fast. There are many examples of MNC strategy that have worked, for instance,
Glaxo Pharmaceutical, HUL and Siemens."
But one grey area, says Patel of Tata AMC, is wholly-owned subsidiaries set up by some
MNCs. "This means one may not get a clear picture of which costs are being charged to
the listed entity and which are being charged to the wholly-owned subsidiary." At times,
these subsidiaries may start operating in the same line of business as the listed entity,
harming the interests of the latter's small shareholders.
Also, the local listed entity can decide to increase royalty payments to the parent. This is
not in the best interest of shareholders. "Dividends are fine as they benefit small investors
also, but not royalty payments," says Gupta of Arthveda.
Investors should look at the sector the MNC in question operates and understand the
industry situation to see if the bet will work. "For example, Siemens is in the engineering
sector and will, therefore, benefit from a stable government and pick-up in infrastructure
activity, whereas if you take Glaxo Pharmaceuticals, it is a perpetual story, as
pharmaceuticals will continue to grow at a certain rate."
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MYTH: FOLLOWING AN EXPERT'S PORTFOLIO IS REWARDING.
Reality: Copycat investing involves following an expert. This is common in developed
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countries. It is also called tail-coating or sidecar investing.
In 2008, Prof Gerald Martin and John Puthenpurackal published a paper titled, "Imitation
Is the Sincerest Form of Flattery". They created a portfolio that mimicked the investments
of Warren Buffett's Berkshire Hathway. The hypothetical portfolio bought stocks at the start
of the month after Berkshire's disclosure of its stock positions. Despite the delayed
investment, the portfolio earned a return of 10.75% over that given by the S&P 500 index.
The study supported the copy-cat strategy.
In India, the most renowned stock investor is Rakesh Jhunjhunwala. So we tried to get
data to see companies in which he has a stake of more than 1% (it is mandatory for
companies to disclose the names of all investors who hold more than 1% shares). This
proved tricky as there were many permutation combinations ranging from Rakesh
Jhunjhunwala to Rakesh Radheshyam Jhunjhunwala and some shares were in the name
of his wife Rekha Jhunjhunwala. In some cases, both their names were combined as
Rakesh-Rekha Jhunjhunwala. So, we took names where we had confidence that it would
be Rakesh Jhunjhunwala.
Throughout 2013, Jhunjhunwala reduced
investment in A2Z Maintenance &
Engineering Services. The stock fell 80%
from Rs 56 to Rs 10 during the period. He
sold Agro Tech Foods shares between
January 2013 and June 2013 and bought
the same between June 2013 and
December 2013 when the price was
between Rs 450 and Rs 580. But we don't
know the price at which he made his
investments.
As this shows, one challenge the investor
who wants to follow the copycat strategy
faces is the deployment time-frame. Gupta
of Arthveda says, "There is no proper way
to do copy-cat investing in India. One hurdle is that you will never know when the investor
you are following has sold his investments. You may not even know when he bought it."
"In the Indian scenario, copycat investing can work only in undervalued companies or
when you are following someone who follows a contrarian style. The contrarian approach
takes a long time to work out. You need patience." He explains that in US, the reason why
the strategy works is the 13F filing. 13F is a quarterly filing by institutional investment
managers with over $100 million in assets. It is done at the end of each quarter within 45
days. Another benefit of the 13F filing is that it is not restricted to 1% shareholding. Hence,
you get to see the full portfolio of the manager.
Therefore, the perennial question for an investor following a copycat strategy is: Why did
the big investor bought it? And, of course, how long does he plan to hold?
Those who want to use the strategy should understand the temperament of the people
they plan to copy. This is because a person interested in short-term trading can never
make money by following a big investor such as Buffett whose holding period is very long.
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MYTH: IF FOREIGN INSTITUTIONAL INVESTORS, OR FIIs, OR DOMESTIC
INSTITUTIONAL INVESTORS, OR DIIs, ARE BUYING A STOCK, IT MUST BE VERY
GOOD.
Reality: The market can take a stock in any direction. In the BSE 100 index, there are 26
companies in which FIIs have been increasing their stake since March 2013. Of these,
nine gave negative returns between April 2013 and February 2014. Similarly, in March-
December 2012, there were 34 companies in which FIIs increased their stake. Of these,
13 gave negative returns in 2012-13.
For instance, FIIs increased stake in Tata Power Company from 24.54% in the quarter
ended March 2013 to 24.78%, 25.05% and 26.03% in quarters ended June, September
and December 2013. However, on account of muted cash flow, the stock plunged 17%
from Rs 95.8 on April 1 last year to Rs 79.45 on February 26 this year.
Likewise, concerns over high debt and soaring interest costs are keeping Jaiprakash
Associates under pressure. The stock fell 38% to Rs 41.90 between 1 April 2013 and
February 28 this year. This was despite FIIs increasing stake from 22.77% in March 2013
to 27.41 in December 2013.
What retail investors forget is that FIIs and DIIs have their own parameters for taking
investment decisions. Pankaj Pandey, head of research, ICICIdirect, says, "If FIIs are
facing a liquidity crunch they may sell even good stocks to raise money. In this case, a
retail investor who follows FIIs/DIIs and sells the stock will miss the chance to make
money."
"The risk appetite, the investment horizon as well as the holding power of retail investors
are different from that of institutional investors. Hence, if an investor buys a stock that FIIs
are buying and it falls in the near or medium term, retail investors without deep pockets
will tend to exit, losing money." However, institutions, which have deep pockets, may be
able to wait for longer to get out of the investment.
Vikram Dhawan, director, Equentis Capital, says the strategy suits long-term investors
who have the discipline and resolve to accumulate stocks at every sizeable correction or
short-term traders who have fixed profit and loss targets.
"One also needs to understand that what may look like a huge stake may be a minuscule
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portion of the FII's portfolio. So, they can dump a few stocks anytime without a big impact
on their overall portfolio," says Patel of Tata Asset Management.
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MYTH: THE STOCK WILL RISE WHENEVER PROMOTERS SHOW CONFIDENCE IN
THE COMPANY BY RAISING THEIR STAKE.
Reality: There is no direct correlation between the two. In the BSE 500 index, there are
270 stocks in which promoters have been increasing or maintaining their stake for the past
five quarters till December 2013. Of these, 140 gave negative returns during the period.
Paresh Shah, managing director, equities,
Centrum Broking, says, "A stock can fall
due to the company reporting lower
earnings growth vis-a-vis others in spite of
promoters showing confidence in the
company. Other reasons could be fear
over future earnings, exit of financial
institutions due to pledged shares and a
widespread selloff in domestic and global
markets."
Take Rei Agro, Ruchi Soya Industries,
Parsvnath Developers, JBF Industries and
Future Retail. These stocks fell over 30%
this year till March 3 despite promoters
increasing their stake since December
2012.
Rajesh Sharma, director, Capri Global Capital, says, "Following promoters is perhaps one
of the best possible ways of investing. But it requires a lot of hard work."
Before following the strategy, he says, one must look at disclosures about the promoter
and the management. The company, if it is to qualify as an investment, should have
manageable debt and good brands and products. Also, one must see how the
management and the stock have been performing in downturns. "Following promoters like
Ajay Piramal and Mahindras has been rewarding for investors. But if you don't understand
the company and its business model and have not done proper due diligence about
promoters and their business associates, you run the risk of suffering losses."
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MYTH: MOST PEOPLE THINK THAT COMPANIES THAT ARE GOING PUBLIC ARE
FLOURISHING. SECOND, THE ISSUE PRICE IS THE FAIR VALUE OF THE STOCK
AND ONE CANNOT LOSE MONEY BY INVESTING AT THAT PRICE, AND LASTLY, IF
THE ISSUE IS OVERSUBSCRIBED, THE STOCK IS A 'MUST BUY'.
Reality: Some companies go public at a very early stage, before proving their financial
feasibility. Therefore, it is important to know whether the company is raising money for
expansion or clearing debt. You may want to avoid the issue in the latter case unless you
are convinced about the feasibility of the business model and other aspects of the
business.
Many believe that initial public offer, or IPO, prices are fair and so buying at this stage is
the safest way to make money. Chethan Shenoy, vice president, investment products,
Anand Rathi Private Wealth Management, says this is not true as a company's fair value
can be calculated only after taking into account various financial parameters and the
overall economic environment. There are many good and popular companies whose
shares listed below prices at which they were allotted in IPOs.
Listing gains can be expected only in bull markets or when the market sentiment is
positive. For example, in 2007, when the markets were bullish, 100 companies came out
with IPOs. Quite a few generated triple-digit returns on listing. The examples are Everonn
Systems (241%), Allied computers (214%), Religare Enterprises (182%) and Mundra Port
(118%).
Similarly, in the bear markets of 2008 & 2011, Tree House, Reliance Power and Omkar
Speciality shares listed below their issue prices. In 2008, nearly 50% IPOs gave negative
returns on listing, whereas in the bull market of 2005 just 12% IPOs gave negative returns
on listing. In 2005, the Sensex had risen 42%. In 2008 and 2011, it fell 110% and 25%,
respectively.
Shenoy says oversubscription does not guarantee high returns either. Misreading the
initial demand for a public issue can have damaging consequences. This is because
oversubscription in itself does not prove that the shares are fairly valued.
While there are enough instances of IPO investing working for small investors, there is no
shortage of cases where they have disappointed.
For instance, CARE announced its IPO in December 2012 at Rs 750 per share. The issue
was subscribed 40.98 times. The stock ended the listing day at Rs 923.95, around 23%
higher than the issue price. Similarly, ICRA announced its IPO in March 2007 at Rs 330
per share. The issue was subscribed 75 times. The stock ended the listing day at Rs
797.6, over 140% higher than the issue price.
However, there have been some big flops too. Reliance Power announced its IPO in
February 2008 at Rs 450 a share. The issue was subscribed 73 times. However, the stock
fell 17% on the listing day.
Experts say IPOs should be approached just like any other form of equity investing. As
such, investors should first analyse if the price at which the shares are being offered is
right. For this, they can look at the PE ratio, the price-tobook value, or P/BV, ratio,
earnings growth and prospects vis-a-vis peers to check if the issue is undervalued, fairly
valued or overvalued.
S Ranganathan, head of research, LKP Securities, says, "An IPO investor should also
study the promoter background, competitive positioning, pricing power and valuation so
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that he is better prepared to take a call on listing."
Gupta of Arthveda says the IPO strategy does not work anymore. This is because the
issues are overpriced as companies' sole aim is to raise as much money from the public
as possible, he says.
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MYTH: SOME INVESTORS SELL STOCKS WHICH ARE ABOVE THEIR PREVIOUS
52-WEEK HIGH ON EXPECTATION OF A CORRECTION AND BUY THOSE BELOW
52-WEEK LOWS.
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Reality: Contrarian investors try to bring the price of securities back to their fair value by
adopting strategies like "winners are punished" and "losers and purchased". According to
market experts, the investor who always sells stocks when they are above their 52-week
highs is taking a high risk; in a bull market, good stocks will move first and poor quality
stocks will follow. If the investor does not know the correct value of the stock but wants to
create a short position, he may end with huge losses.
However, in a bear market, fundamentally poor stocks will touch new lows every day.
Buying these can erode wealth as there is no way one can know when the fall will stop. A
good example of this is infrastructure stocks, which fell 30-75% in the four years to
December 2013.
Sahil Kapoor, chief technical strategist, retail capital markets, Edelweiss Financial
Services, says, "Technical analysis is based upon the belief in buying strength and selling
weakness. Hence, if a stock has made a new 52-week high, it means it has strong relative
strength compared to others. A 52-week high breakout after consolidation has even more
significance as there is a range expansion and the stock is ready for a strong and a
sustainable trend."
Markets generally prefer quality stocks
and those which remain above 52-week
highs always find dedicated buyers.
Stocks which are battered and unable to
bounce from lows are generally not
favoured.
"An important reason to avoid bottom-
fishing in 52-week-low stocks is the
difficulty of spotting winners. The
probability of losing money is higher. If you
were to buy stocks making new highs, the
probability that you will pick more winners
than losers is higher," says Kapoor.
Varun Goel, head, portfolio management
service, Karvy Stock Broking, says,
"Fundamentally, there is no reason to
buy/sell a stock if it is at a 52-week high/low. Some technical analysts do look at these
figures but just to understand the momentum in the stock. If a person is buying a stock just
because it is at a 52-week low, he could fall into a value trap."
For example, Hindustan Unilever (HUL) made a new 52-week high in September 2010 by
crossing Rs 300 after 10 years. Investors would have earned handsome returns even if
they had bought the stock at these levels. The stock rose more than 100% after that to
touch a new high of Rs 718.90 in July 2013. In March, it was at Rs 555.
Similarly, IVRCL made a new 52-week low in 2010 by breaking the Rs 140 level. On
March 4, it was trading at Rs 11.06.
"Investors should maintain a 5-7% stop loss once a stock touches a 52-week high. If the
strength and range expansion persist, there is a high probability that the stock will give
20%-plus returns in the medium term. Only those who have trading skills and discipline
should use the above style," says Kapoor of Edelweiss Financial Services.
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MYTH: PENNY STOCKS ARE SO CHEAP THAT THEY CAN MAKE A PERSON RICH
OVERNIGHT.
Reality: There are a
number of penny stocks
which have made investors
rich. For example, Core
Education & Technologies,
which was trading at Rs 12
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paise on 1 March 2004,
rose 122 times in 10 years;
it touched Rs 14.44 on
March 3 this year.
On the other hand, SMS
Techsoft (India) has fallen
over 76% in the past 10
years, and was at Rs 0.09
on March 3 this year.
Nu-Tech Corporation
Services fell over 66%
during the period.
A penny stock normally
trades at a very low price,
usually below Rs 10, or is
issued by a company
whose market capitalisation
is less than Rs 100 crore.
"Penny stocks are risky.
Chances of huge profits
usually come with even
bigger chances of suffering
losses. Hence, it is best for
the risk-averse to avoid
these stocks. However, if
the investor has the risk
appetite, he must take
pains to understand the
company's financials and
the risks involved and
decide the horizon for
which he wishes to hold the
stock. Penny stocks may yield good returns due to changes in business fortune or
management, favourable policy changes or takeover by a good company," says Yashpal
Gupta of IDBI Capital Market Services.
According to experts, penny stocks are not great options if one is looking for a way to get
rich quickly. When one invests in penny stocks, a huge profit isn't guaranteed. Just
because a stock is cheap does not mean that it is a good bargain. Hence, investors must
do thorough research and be ready to hold such stocks for long periods.
The other reason for buying these stocks is that these are available at low prices and can
be bought in huge numbers with a small capital. People perceive these stocks to be
'cheap' and a way to overnight fortunes.
Rakesh Goyal, senior vice president, Bonanza Portfolio, says, "Stocks cannot be tagged
as cheap or expensive solely on the basis of their market price. Stocks are valued on the
basis of their fundamentals-their net worth, business potential, income growth, etc. So, if a
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stock is trading at a low price, it is primarily because markets do not value it much in terms
net worth or growth. Thus, every penny stock may not be a bargain. People also buy
penny stocks in the belief that a small addition to the price can bring in huge profits."
For example, if someone spends Rs 10,000 to buy a stock valued at Rs 2 a share and if
the share price reaches Rs 3, he will earn a profit of Rs 5,000 on an investment of Rs
10,000. However, for the stock to give a return of Re 1, it will have to move by 50% in a
particular period.
In case you are keen to buy a penny stock, it is advisable that you start only after reading
the company's financial statements and doing proper research about business plans and
strategy.
"One should stop investing in the stock when the company is not performing well. Further,
if there is negligible possibility of a company turning around, then also one should stop
investing in such stocks," says Yashpal Gupta of IDBI Capital Market Services.
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21 of 21 4/17/2014 3:01 PM

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