Penny Stocks: How to choose to invest?

Notwithstanding the higher risks attached, the small and micro companies (also known as penny stocks) do pay higher gains provided the investor knows fully about the management and quality of management. But choosing small and micro cap stocks is tougher job than picking the mid cap or large cap shares.

The investor needs to do more homework before picking the small cap companies even try to interact with the management directly in order to understand their qualitative features such as risk appetite, morals, intension to share the wealth, etc.

The interesting phenomena of these companies will surfaces when the markets are vibrant and that they even announce dividends to capitalise on the price movement. Investing in the troubled business but with a good management will give better returns than investing in good business under bad management.

Investors are attracted to booming sectors at a particular phase, such as IT boom, where lot of individuals have invested in IT companies and most of them are left in lurch. And now we see a boom in e-retail platforms.

Of course, there may be some genuine promoters but we can see those who like to make quick bucks also enter during this phase. Here, the investor needs to have the art of differentiating.Usually investors look to the financials of the company before investing, which is just a scientific evaluation of the firm.

But the qualitative aspect of management would come out by analysing the issues like: the way the managements utilise the resources, the churning of employee turnout, especially the top non-promoter professionals, etc. Investor should give more weightage to quality of management.

Generally, the managements of small companies, which are listed, will also have similar companies operating under them that are unlisted ones. While in listed companies the promoters will have lesser stakes than unlisted companies, and they do business on unlisted company.

Another financial feature of small companies will be higher debt to equity ratio and the bankers will have first charge on their assets. The shareholders will not get reward from these companies.This discussion is not to discourage the investor, but a word of caution to protect their hard earned income.

It is true there are good companies, which are listed and continuing as small equity companies for various reasons. The small cap companies will have lesser liquidity for their stock and will test the patience of investors.

There are good stocks with very strong fundamentals and being operated under proven managements. They may be operating in bad sectors with small equity and waiting for the sector to open up.

Since media will not cover these companies, it is difficult to get analytical information about these companies. The investors have to discover these companies and bring them to the light. The shy managements do organise general body meetings in remote places to discourage investors to attend the meetings.

But the managements that like to share profits with retail investors will not like to stay as small cap companies for long. They prefer to build brand image and good exposure in the investment markets.

Thus, it is always advisable to keep off from small companies, at least, till such time the small investors gain knowledge to differentiate between good and bad companies independently, without external advice.

Till then, they can invest in known companies where returns may be less but capital is protected.While low price may attract investors, but it is always better to invest in good large cap stocks.

By:KVVV Charya