What Are Penny Stocks? Pros and Cons of Penny Stocks

What are Penny Stocks?

Penny Stocks have always attracted investors, because they are a form of security which are traded at minimal pricing. Companies which have a low market capitalization rate offer stocks at minimal pricing, and these stocks are known as Penny Stocks. Penny Stocks are also known as Small Cap Stocks, Nano Cap Stocks or Microcap Stocks, based on the market capitalization of the company.

To understand about penny stocks, it is important to know what is meant by market capitalization of the company. The market capitalization of a company is simply the product of current price of its stocks or shares and the total outstanding shares.

The companies with a market capitalization of over Rs. 20,000 Crore are known as large cap companies and the companies having a market capitalization of Rs. 5000 Crore or below are known as Small cap companies. The remaining ones are Mid-Cap companies.

Market capitalization is one of the most important factors for indexing companies on the exchanges. Penny stocks are usually found in the lower sections of stock exchanges.

Advantages of Penny Stocks

Penny Stocks have numerous features and advantages.

• Low Cost: As we already discussed, penny stocks are available at minimal pricing. In the Indian markets these stocks are usually available at a price below Rs 10 per share. Therefore, even if you have a small investment capital, you can purchase a substantial number of shares for your investment due to the low pricing.
• High Returns:Penny stocks are issued by small cap companies which are either new in the market or in their growing stage. Such companies have a great potential and scope for growth which can directly affect the stock prices. Therefore, these stocks are capable of yielding high returns compared to other securities.
• Unpredictable Pricing:Since these stocks are issued by small cap companies, which are not very popular in the market, there are chances that they can attract significantly higher price in the market when you try to sell them which will result in a considerable amount of profit.

Risks Associated with Penny Stocks

Penny stocks, like any other investment option have certain risks associated with some. Some of the risks associated with Penny Stocks include:

• Limited Information: Since penny stocks are usually issued by startup or growing companies, there is hardly any information available about the company history and its financial soundness. Therefore, there are high chances that you could invest in a company which may not have growth prospects leading to a decline in share prices.

  It is important to have a through research about the company fundamentals before investing. A SEBI registered investment advisor can help you in conducting fundamental research about a company.

• Illiquid:Buying penny stocks are easy, but given the low popularity of the companies, it can become challenging to find out buyers for your stocks when you wish to liquidate them. During emergencies, it can be very difficult to find out potential buyers who are willing to buy the stocks of such companies, resulting in poor liquidity.
• Prone to Scams::If we take a look at the history of scams, penny stock scams have been very common. One of the common scams associated with penny stocks is the Pump and Dump strategy, where companies and fellow investors buy considerable number of shares to inflate the prices, which attracts other investors to buy the stocks.

Why Should You Invest in Penny Stocks?

Penny stocks are considered as a hit or miss investment option. When invested with proper research, there are chances that these stocks can be multi baggers. It means that the stock can provide returns, multiple times of the initial investment price. If the stocks return ten times the value of the investment, they are known as ten baggers.

Also, the availability of these stocks at low prices allow you to invest in large quantities with nominal capital. Including them in your portfolio can be very beneficial from the diversification point of view. These stocks at times can even outperform midcap and blue-chip stocks of your portfolio.