Low-priced stocks: A roulette that may well be a losing bet, say experts

Many have weak fundamentals to back share price rise and may not live to see the next bull run: Experts

Stocks trading at a low price denomination have risen sharply, largely due to speculator interest or new investors trading actively during the pandemic.

The S&P BSE Sensex has gained 135 per cent from the lows it hit on March 23, 2020. And 666 of the 833 stocks trading at Rs 20 or below in March 2020 have outperformed the index. Even from a one-year perspective, 657 of these stocks have outperformed the Sensex in 2021. In fact, some of these stocks have seen gains between 50x and 80x in less than two years.

Of the 508 stocks trading at Rs 10 or below (popularly known as penny stocks) during March 2020, 438 have outperformed the Sensex. And 401 outperformed the index last year as well. The rally in these stocks when the economy faced bouts of disruptions due to Covid-19 has baffled analysts.

Experts say there is a tendency among retail investors to conclude that a stock trading at a high price may not gain much, and a stock trading at a low price is ‘cheap’. In the case of the latter, the low price of stocks itself attracts investors, and they rise on speculation. The sharp gains encourage traders and speculators to take large positions for making a quick buck.

“New investors have come in droves to the equity market in the last two years. Most of them are investing in small-cap stocks or low-denomination stocks. Even old investors are feeding off this frenzy by taking positions in low-denomination stocks,” says Chokkalingam G, founder, Equinomics Research & Advisory.

Chokkalingam says the gains in low-denomination stocks are a natural extension of the gains in the broader markets since March 2020.

The BSE SmallCap Index has gained 249 per cent since March 2020, and 63 per cent last year. The MidCap Index gained 169 per cent since March 2020, and 39 per cent last year.

Many of these investors, according to analysts, are millennials who turned to stocks due to a lack of returns from other assets and due to lockdown-induced restiveness. However, analysts doubted how long these gains would sustain as market support in the form of monetary easing would come to an end this year or if leading indices were to see correction.

Some experts allege that gullible investors are taking positions without studying company fundamentals on the basis of advice from shady operators masquerading as analysts and veteran traders on chat groups.

“Most of these operators have their own subscriber base through WhatsApp groups and Telegram channels,” says Ambareesh Baliga, an independent markets analyst.

Experts caution investors against taking large or small positions in these stocks, saying when markets correct, people will either lose money or will have to wait until the next boom in the hope their holdings will also see recovery to their cost price.

“This party will not go on, and I expect a crash by the end of this year. Rarely has the broader market outperformed the index for more than two years on the trot. The liquidity is limited in these stocks. Investing in these stocks is akin to playing Russian roulette. It's better to avoid huge investments,” says Chokkalingam.

Baliga says some of these penny stocks will not live to see the next bull run. “Between two bull runs, a number of stocks get delisted. Investors have to be very agile. The best advice would be to not get into these stocks. But it won't make sense when stocks are going up sharply. So the practical advice would be to book profits when you see a downward movement,” advises Baliga.

Another market expert, though, says, this is the right time to exit such stocks. As when markets correct or when the tide reverses, many of these stocks are more likely to hit lower circuits (no buyers in the counter), leaving no exit opportunity for naïve investors. 

“Waiting for the top to exit may not be a good thing. When markets are near highs after a stellar run, it is advisable to let go of an opportunity in speculative trades, rather than end up with ‘real’ losses,” he says.