Penny stocks - a high risk high reward game

MUMBAI: In a study to determine whether the interest in penny stocks is justified, ET Intelligence Group undertook to study the performance of penny stocks over the last five years since 2008. There is no formal definition of penny stocks but the US regulator Securities and Exchange Commission (SEC) considers stocks trading below $5 to be penny stocks. For the purpose of this study, penny stocks have been considered to be those trading below Rs 10 on the bourses.

Of the 494 stocks that were found to penny stocks (i.e. trading below Rs 10) at the beginning of 2008, 115 logged gains over the next five years. Of these, 91 cease to be penny stock as their price moved above Rs 10.

However, it is not that all the 91 companies turned out to be strong performers financially. Frontline Business Solutions, the company whose stock gained the most - rising from Rs 1.5 to Rs 178 in the past five years, has a market capitalisation of Rs 175 crore - 19 times its sales - a valuation that appears unjustified. Interestingly, 25 of these 91 companies are from the financial services sector followed by 9 from IT-related field.

Only one-third (29 companies) of these have revenues (on a trailing twelve months basis) higher than Rs 50 crore as well as earning profits. Manappuram Finance, Kwality Dairy, Responsive Industries, Vakrangee Softwares and Ausom Enterprise are the top five companies of this list.

These statistics just reiterate that penny stocks remain a high-risk high reward game meant only for investors with high-risk appetite.