Share investment carries a fair amount of risk, especially if you are a new investor. One of the primary challenges is identifying the right stocks for investment. You will often come across terms like penny and value stocks while investing. These are varieties of stocks.
What are penny stocks?
The term penny stock refers to stocks that are low value, usually Rs 10 or less. It is important to note that a regular stock can also have low value, but those aren’t penny stocks. Penny stocks are typically high-risk stocks. Some investors believe that sourcing penny stocks is a route to find the next big hit like Amazon or Facebook.
Often penny stocks and small-cap stocks represent stocks from companies with small capitalization. But there is an important distinction. Penny stocks are low price and market capitalization, often traded over the counter instead of being listed on the exchange. However, small-cap stocks are based on a company’s market capitalization, not on its price or where it is listed.
Penny stocks are high-risk securities from companies with small market capitalization, listed outside significant exchanges. It is a term used interchangeably with micro-cap stocks. However, the basis of classifying micro-cap stocks is only the market capitalization value of the company and not the price.
Why are penny stocks risky?
Penny stocks are riskier than regular stocks. Here is why.
Lack of tangible knowledge
Making an informed decision is critical for successful investment. But in the case of penny stocks, information is difficult to get. These stocks are often traded outside major exchanges meaning they don’t need to file with the SEBI.
No minimum standards
Companies listed on the primary bourses need to fulfil several listing standards. But stocks falling in the penny stocks category don’t need to meet these standards. Sometimes, companies can’t maintain their positions in the major stock exchanges and move to smaller, non-standard bourses. It is often the case with penny stocks. The minimum standard requirements to remain listed are a safeguard for investors and a benchmark for companies.
Penny Stock – Little history
There is often no history available on penny stocks. The micro-cap stocks are often from new companies, firms approaching bankruptcy, or having ongoing litigation against them. They usually have poor track records, but the lack of historical information makes it difficult to gauge future returns on the stock.
Penny stocks may sound like an attractive investment, but one major challenge with these stocks is liquidity. You may not find many takers for these stocks, which can be a problem when trying to redeem them.
Low liquidity can also prompt some investors to manipulate the stock price unethically. One of the simplest methods is to increase the price by buying large volumes and then selling it off when more investors participate. It is called the pump and dump method.
Also Read: Best Penny Stocks To Buy In India
What are value stocks?
Value stocks lie on the opposite of the pole of penny stocks.
A value stock is a regular stock, usually of fundamentally strong companies, trading at a lower rate than their actual market price. Their lower price is because investors see them as unfavourable for investing. Sometimes market overreacts to news, resulting in a share price change. As a result, these stocks trade at a lower price than their intrinsic value. The foundation of value investing is based on these value stocks.
It proposes that the market will eventually discover the true potential of the undervalued stock. And finally, the price of the undervalued stock will adjust to the market potential, resulting in good profit.
Penny stocks are risky and often used in stock market scams. Instead of risking your hard-earned money in penny stocks, invest in value stocks. Value stocks are shares of companies that are trading at a lower price relative to their fundamentals. These companies meet all standards set by the SEBI. Usually, the shares trade at a bargain rate because investors consider them unfavourable in the marketplace.
Now that you have learned about both penny stocks and value stocks, we recommend you consider all options carefully before investing. Open a demat account in under five minutes and start your investment journey.
Disclaimer: “This blog is exclusively for educational purposes and does not provide any advice/tips on Investment or recommend buying and selling any stock”