Why you should not invest in junk stocks

When a large retail chain announced a mega discount sale of electronic goods, buyers turned up in large numbers. Top quality products were selling very cheap. As word spread, more buyers poured in. The discount was lowered but that didn’t dampen the mood of buyers. After all the good stuff was sold off, the store put medium quality products on sale. Even that got sold out in no time. Though there was nothing left to sell, the demand did not abate. That’s when the store decided to sell the faulty products and useless stuff lying in its godown. To its delight, the buyers happily bought the useless and faulty products, unmindful of their quality or utility.

Something similar happens in the stock markets from time to time. Intelligent investors are the early birds who pick up quality stocks when they are trading at low prices. As volumes pick up, more investors jump in and start buying, though prices are higher. There is a lot of euphoria and eventually, all good quality stocks are taken. That is when newbie investors come into the market. Since good quality products (read, stocks) are now selling at a higher price, they are attracted to the low prices of other products (read, penny stocks).

This obsessive love for lowpriced stocks (also known as bhangaar cap to reflect their utility) is the tragedy of the small investor. After he misses the opportunity to invest in good quality stocks at low prices, he jumps in and invests on the basis of tips from dubious brokers. Brokers work in tandem to recommended bhangaar cap stocks and create euphoria about certain scrips. The newbie investor believes these tips and invests blindly in junk scrips.

Investors suffer loss of capital when markets recede. But the bigger loss is the loss of confidence in the equity markets. You may be able to recover the loss of capital when markets bounce back, but confidence once shattered can take years, even decades to recover. And bhangaar cap stocks fall the hardest when the stock markets recede, mauling the confidence of the new investor.

Investors should be like the early birds who managed to buy good quality stuff. If you missed the bus, don’t jump in late and buy junk stocks. There are thousands of such stocks trading on Indian stocks exchanges.

The stock market is a double edged sword. Good decisions can create wealth but mistakes can destroy it too. It takes discipline to be a successful investor. The desire to make money overnight is the reason why many investors fail. Remember, it took years to build Rome. But Hiroshima and Nagasaki were destroyed in a day.

(By Vijay Kedia, MD of Kedia Securities, and a seasoned stock investor.)