It's time to get penny wise on Dalal Street

The capital market is witnessing a paradox as far as penny stocks are concerned: those relatively dormant are shooting past the index heavy weights in price rise sweepstakes, of late.

Analysts are of the opinion that small investors should be careful while investing as several penny stocks have risen at a faster pace than their index counterparts for the last few days.

A glance through Friday's top gainers from all groups on BSE throws up the following fact: eight scrips among the top 20 stocks, which rose 20 per cent on Friday, were those priced below Rs 10.

Of the eight low-priced stocks, four were from the Z-group, one from the T group and three from B2 group. The Z-group stocks on the Bombay Stock Exchange (BSE) consists of shares of those companies which violated the listing agreement consistently.

As many as nine out of the 20 stocks have plunged below Rs 2 at least once during the last 52 weeks.

Two non-banking finance companies' (NBFCs) stocks in the Z-group "" Elgi Finance and Ushakiran Finance "" topped the list of 20 that hit the upper circuit of 20 per cent on Friday.

Both the companies have reported losses of around Rs 3 crore for the fiscal ended March 2005 and, thus, had a negative EPS.

According to the data available with BSE, both the stocks had not reported any trade about a week ago or a month back.

The stock of Elgi, which closed near its 52-week high of Rs 7.75 on Friday, had a 52-week low of Rs 1.21 on September 29, 2004.

Ushakiran too hit a 52-week low of Rs 5.75 on September 23, 2004. Volumes were also thin in both the stocks at 400 and 100 shares, respectively, on Friday.

EPC Industries and Shree Steel Wire Ropes also had a fairly good run on the bourses rising from Rs 1.60 on July 14, 2004 and Rs 2.30 on March 2, 2005 to close at Rs 7.50 and Rs 7.92, respectively, on Friday.

Of the four non Z-group penny stocks in the list of the top 20, Everlon Synthetics (B2), Procal Electronics (B2) and SMR Unisoft have incurred losses during 2004-05.

but rose from their lows of Rs 1.30 (June 6, 2005), Rs 0.55 (July 20, 2004) and Rs 1.01 (August 18, 2004) to touch their peaks of Rs 8.82, Rs 3.30 and Rs 3.66, respectively, on Friday.

The other penny stock in the B2-group, Capital Trust has a P/E multiple of 33 at its present price of Rs 6. On the basis of price-earnings (P/E) multiple, Shree Steel (23 times) and Om Metals and Minerals (14 times) are much ahead of index heavyweights such as Tata Steel (5.61 times) and SAIL (3.17 times), though they are not strictly comparable based on their nature of business.

Tools manufacturer Akar Tools has a P/E of 46 times. There is no doubt that many a small investors have reaped benefits on their investments in small stocks during the recent protracted bull run.

But a change in the situation will prove disastrous for these investors. In some cases, they may lose whole of their investments if these stocks remain without trades for months.

"Usually, small investors who bank on low-priced stocks (called penny stocks) will benefit as long as the market is on the uptrend, fuelled by inflow of investments by foreign institutional investors (FIIs) and other institutional investors.

But a reversal would take these stocks back to their early levels at the same pace, which will make them dormant awaiting another bull run," Dr VVLN Sastry, country head, Firstcall India Equity Advisors, says.

However, there is another scenario where some operators enter the market with a specific purpose of boosting certain penny stocks during a persistent bull run, which blurs the distinction between index or other stocks to a great extent.

Along with fundamentally strong companies, dormant stocks too find takers then. "This happens since small investors look for stocks that match his/her investment capacity. Such investors mostly go by word of mouth counsel of friends and relatives," Dr Sastry says.

Sharmila Joshi of Asit C Mehta says, "There are many investors who have raked in money during the boomtime, so far. They pick up momentum stocks and try not to get at the wrong end of the stick. But some kind of investment discipline of analysing the risk associated with a stock and evaluating its prospects help these people."

"However, the same is not true with those driven only with a penchant for making money, without backing it with evaluation of fundamentals or taking expert counsel. Mostly they take a gamble," Ms Sharmila added.

However, bringing down the exposures at regular intervals as the prices rise is as important for small investors investing in low-priced stocks, she says.

Dr Sastry says, "To avoid stocks which fall like hot potatoes at when there is a trend reversal in a bull market, investors must be able to study the fundamentals of the stocks and select the target stocks or identify turnaround stocks and stick to them."