There are thousands of businesses that offer up their equity to investors in order to raise capital. This is done by putting up their shares for purchase. However not all such businesses trade on the major stock exchanges such as the NSE and the BSE. There are approximately 5000 companies listed on the Bombay Stock Exchange (BSE) and some 1600 companies listed on the National Stock Exchange (NSE). This is far from the sum total of all the companies whose stock is traded in the markets. These other stocks that are not traded on the exchanges are called Over the counter stocks or OTC stocks.
What are Over the counter stocks?
Over the counter, stocks are stocks that are not traded on the stock exchanges because they do not meet the stringent requirements laid down for listing by the exchanges. For instance, on the BSE, the listing criteria for small-cap companies require a minimum post-issue paid-up capital of Rs. 3 crores and minimum market capitalization of Rs. 5 crores. Companies that do not meet these criteria can still issue shares but these shares cannot be traded on the BSE. Similar rules apply to the NSE. The stocks of such companies that are not traded on the major stock exchanges can be bought from full-service brokers and are called OTC stocks or penny stocks.
Advantages and Risks of OTC stocks
Away from the fast-paced world of stock exchanges, there is a thriving OTC stock market where such penny stocks are actively traded. People invest in OTC stocks because:
OTC stocks are cheap
They are also called penny stocks because of their low prices. As a result, investors can potentially buy a large number of such stocks.
Growth Potential
Some good OTC stocks have the potential of giving multi-bagger returns and as a result investors are always on the lookout for such stocks. However, such stocks are very few, and finding them requires a lot of painstaking research.
Potentially Limited Risk
Many investors believe that since OTC stocks are cheap with potential for great returns, this limits their downside as a lower investment would mean potentially lower loss.
However, investors need to beware of OTC stocks as they also come with great potential risks.
Lack of Transparency
Since OTC stocks are not listed on exchanges, they do not have to follow mandatory disclosure regulations, and as a result, very little information is usually available to the investor about them. In the absence of any reliable information about the company’s finances, it is difficult to make informed investment decisions.
Lack of Liquidity
OTC stocks are not highly liquid because of the small size of the issuer. This means there is very low volume when trading an OTC stock. An investor is always at risk of getting stuck with an OTC stock as he/she may not be able to find a buyer due to the low volumes. By comparison, stocks traded on exchanges generally have healthy volumes and an investor can always find a buyer or a seller for a good stock.
Susceptible to Scams
OTC stocks are often the subject of scams such as pump-and-dump schemes in which miscreants create unethically promote an OTC stock using social media or messaging services to lure gullible investors into buying them. Once the price of the stock goes up on account of a sufficient number of investors having bought it, the miscreants sell off their shares, leaving investors in the lurch.
How to Buy Over the counter stocks
Unlike normal stocks, OTC stocks cannot always be bought using your online demat account as OTC stocks do not trade on the major exchanges. To buy OTC stocks you will need the services of a full-service broker. Stock market brokers are of two types:
Full-service Brokers
Full-service brokers provide the complete range of equities markets related services from buying and selling of stocks to trading advice to portfolio management services. Full-service brokers have a physical presence in the form of offices in the geographies that they operate in and this allows them to offer a much wider range of services.
Discount Brokers
Discount brokers allow users to trade in the markets, usually using a demat account and an online trading platform. Most online brokers are discount brokers. They provide limited services at a discounted fee.
Over the counter, stocks can thus only be bought from full-service brokers as they have a physical presence in the areas they operate.
Conclusion
Over the counter or OTC stocks are penny stocks of companies that are not listed on the major stock exchanges. They are attractive because of their low prices and potential for faster growth. However, they also come with greater risks, lower trading volume, and a lack of information about the financials of the underlying business. They are also susceptible to scams such as pump-and-dump schemes. However, some OTC stocks can be genuinely good investments. Many big companies of today started trading first as penny or OTC stocks. Investors can trade in OTC stocks provided they have done their research and are sure of a particular company’s growth prospects. OTC stocks can be bought from most full-service brokers.
