By Ruma Dubey

Sometimes, it is difficult to understand the psyche of the investor. In a bull market, when the markets are booming and almost all stocks have run much ahead of valuation, hunting for penny stocks comes naturally, or should we say, is any hunters instinct. But in a bear market, when blue chips are better priced and hold promise of bigger gains when times improve, why then this pursuit for penny stocks?

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.

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.

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 on Friday. Sawaca Business Machines, which states its business as a “miscellaneous commercial services” hit a new 52-week high at Rs.95.30 (frozen at upper ciruit) and less than a year ago, on 17th June 2011 to be more precise, had hit a new 52-week low at Rs.7.13. An appreciation of over 13 times within 12 months!  The company for Q4FY12 posted a revenue of Rs.10 lakh and net profit of Rs.one lakh. Its market cap is at Rs.99 crore.

Parikh Herbals needs special mention. On 16th Jan 2012, the stock was at Rs.50 and on 25th May, within four months, it hit Rs.412; a gain of over 8 times! But its market cap is bigger at Rs.412 crore though it performance is like a penny stock.

Another company which had hit a new 52-week high on Friday, 25th May, was Osian Industries at Rs.126.05. The company engaged in manufacture and trading of rexine, for Q4FY12 had a net profit at Rs.2.16 lakh, promoters stake is pathetic at 10.50% and market cap is at Rs.63 crore.  Shree Shalin Textiles, Sulabh Engineers, Gee El Woollens, Kothari World Finance, Nimbus Projects, Spectrum Foods are some of the other penny stocks which hit new highs on 25th May. Of the total 17 stocks which had hit a new high, 9 were penny stocks.

Then there are others like Tuni textiles, Kaleidoscope Films, Roselabs Industries, Well Pack Papers,
Mahan Industries, Bodal Chemicals and Interlink Petroleum which remain active though performance is not even worth mentioning.  Similar stocks, which one should be wary of : Alufluoride, Arms Paper, Asahi Infra, Avon Corp, Bala Techno, beckons Inds, BLB, Daikaffil Chem, GSB Finance, Kaashyap Tech, Kohinoor Broadcasting, Kohinoor Techno, Mardia Samyoung Capillary, Netvista Information Tech, Sam Industries , Tyche Industries , Unique Organics , Southern Ispat & Energy , Proto Developers & Tech, Uniroyal Industries, NGL Fine Chem  and many more.

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.