By Ruma Dubey

We are currently in a situation, at least most of the retail investors, where we can only watch the bull run and quality stocks hitting new highs. Two factors deter our getting in – most of the good stocks, even mediocre stocks are at unaffordable prices and secondly, the high prices could mean lesser profits on the table. Thus there is now a pursuit for penny stocks.

This is how it always happens. When prices skyrocket, the usual suspects, the smallcap, penny stocks start showing a lot of momentum. Retail investors want to constantly buy into such stocks, hoping that one day it turns into an Infosys or L&T.

We have many investors/traders posting us queries on the website, asking for some penny stock ideas. The only question which comes to mind is “why?” This search for the elusive pot of gold at the end of the brilliant rainbow is what puts traders at risk. And this is a dangerous time to be on the hunt for penny stocks and it is actually the perfect time to stand back and look at where and what we are investing in. Wait for the dust to settle before you take a call on large cap stocks too!

The one omnipresent character of all traders buying and selling shares on the bourses is greed. Even if a trader, in a particular stock is in handsome profits, he continues to hold, hoping to make more. And then
there are the other traders, the high risk traders, who want to invest only in small cap or penny stocks and hope that one day it becomes a mid cap stock. But does that happen? Maybe we come across a few random cases; there are stories of more losses than gains, yet traders keep a selective memory and buy into penny stocks, only to get trapped. But for those who have been trapped in such stocks since a long time, such markets are a blessing as it gives them an opportunity to exit with the counters once again becoming liquid.

Penny stocks are characterized by scams, with management and manipulative brokers having one point agenda – to snarl susceptible traders. These stocks typically have volatile price variations. The most telling pointer is when a stock has a pitiable volume of trade but yet manages to hit a new high with even every 100 shares traded. Market cap is usually very small. Risk is very high, with dubious credentials of the management. Buying into such stocks is easy but try selling it when the price rises and you will know the true meaning of being trapped in a penny stock. Lack of liquidity and high volatility should be the big blaring warning signs. Delisting is a frequent phenomenon. Brokers go overboard recommending these stocks and SMSes are often used to sell these stocks. Despite all these facts, people constantly ask for advice on which penny stocks to buy.

Take a look at some of the stocks which have hit a new high today. Ahmedabad Steelcraft needs special mention – the stock has a market cap of Rs.13 crore, its net profit for FY14 was not even Rs.2 crore, its been hitting new highs and upper circuits since 30^th June. Today too the same story, with price frozen today at ne high of Rs.31.55.

Another super classic case – Gujchem Distilleries. The stock was frozen today at the upper circuit at Rs.165.90. Its business is “commodity chemicals and for FY14, it had a loss of Rs.22 lakh. Market cap is at a shocking Rs.1 crore.

Enkei Wheels. Have you ever heard of this company? It makes wheels, as the name suggests and its website lists down the who’s who of the Indian auto sector as it customers but sadly it had ended FY14 with a net profit of Rs.53 lakh, market cap is slightly better at Rs.90 crore.

Another major characteristic of this stock – there is no FII holding. A quick retort from a punter for the same – which is why one should buy into this stock now! But what happens when markets settle down and you get stuck in such illiquid stocks?

Mahadushi International Trade is no different. Zero FII holding, the stock had a net profit of just Rs.3 lakh in FY14 and yet, today, it hit a lifetime new high at Rs.561.50. Promoters stake is 15.18% only!

Similar companies which have hit a life time high today are – Mahavir Advanced Remedies, Naisargik Agritech, Pankaj Piyush, Pokarna, Shantanu Sheorey, Eins Edutech, Exdon Trading, ICVL Chemicals. Take a look at the list of stocks which hit a new high today on the BSE and you will see that more than 80% of them are similar stocks.

The list in endless and the queue of traders wanting to pick the next ‘Infosys in the making’ or the next ‘Sterlite in the making’ is growing. And that is worrisome. Mid cap stocks are still a better risk than small caps. And remember – rarely do penny stocks ever become even mid caps, forget becoming large caps.