What comes to mind when you think of a get-rich-quick investment?
NFTs and cryptos?
Well, these are only recent developments. The get-rich-quick idea has existed for a long long time. After all, humans have always been greedy.
So, before crypto entered our lives, penny stocks were the OG (GenZ lingo: original gangster) get-rich-quick opportunity. And they still are.
For example, if you invested Rs. 1 lakh in Brightcom Group shares (a penny stock) three years back, you would have Rs. 91 lakhs right now!
But how do these penny stocks work?
Penny Stocks 101
As the name suggests, penny stocks are stocks that are cheap, often selling for pennies Rs. 0.10 - Rs. 100. There are approximately 1,679 penny stocks trading in India right now.
In contrast, share prices of some of the most popular companies this year are:
Reliance: Rs. 2,258 (as of December 20)
Tata Motors: Rs. 443 (as of December 20)
HUL: Rs. 2,239.45 (as of December 20)
So, how come penny stocks sell for such low prices?
Because they usually belong to microcap companies that have a market cap of less than Rs. 5,000 crores.Â
There are some exceptions, of course. For instance, Vodafone Idea has a market cap of over Rs. 40,373 crores, but its shares are trading at around Rs. 13.
Wondering why doesn't everyone just invest in penny stocks then? You could save so much money by buying these cheap stocks!
Well, well. If making money were so easy, we would all be billionaires. So, what's the catch?
Buckle up, there are many.
High Risk: Since penny stocks mostly belong to small companies, they're extremely risky. Not much information is available about these companies and you don't know whether they'll become successful or not. So, investing in penny stocks is a pure gamble. You may win big or lose it all.Â
Low Liquidity: And because these stocks are so risky, not many people are interested in buying them. Therefore, if you end up buying them, there is a high chance you may not be able to sell them off when you want to.
Easily Manipulated: These stocks are very easy to manipulate. How? Since they're so cheap, a few people could end up buying a large amount at once. This would increase the price of the stock. Now, to some investors, this may seem that the stock is performing really well. So, they might want to get in on the action. And just when more people start buying the stock, increasing the prices further, the original bulk buyers dump their stock and exit. This causes the stock's price to crash and leaves many with worthless stocks that have no buyers now.
And now for those who are data-driven: Out of 521 penny stocks selling for under Rs. 10 in April 2020, only 13 gave five-fold returns. You see the risk of investing in these stocks now?
But lately, penny stocks have been regularly making headlines. And that's simply because the market is in a bull run and people have a lot of extra cash, thanks to low interest rates. When the market crashes, these stocks may (and probably will) be the first to fall.Â
Food for Thought
The main attraction of penny stocks seems to be the low price. Many investors may actually want to invest in companies that give sure-shot returns but may not be able to do so because of their high prices. So, they settle for these penny stocks and end up losing money and their passion for investing.Â
Fractional shares could solve this problem. Umm, what's that?
In countries like the US, you can buy a fraction of a share of a company. So, if Apple shares are selling for Rs. 500, you can buy 1/5th of a share at Rs. 100.Â
But sadly, fractional investing isn't a thing in India yet.Â
Do you think India should also introduce fractional investing? Or will that cause even more chaos?
P.S. This article is not investment advice. It is only meant to educate and inform.
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