What are Penny Stocks?

Case breakdown: Movie Wolf of Wall Street

The scene that you just saw shows you how salesman Jordan Belfort (played by Leonardo di caprio) walks into an Investor Center. He sells penny stocks to the customer with ease, giving a very smooth speech. Salesmen sitting in the office are quite impressed with his acumen for selling. He sells $4,000*10 cents= 40,000 shares of Aerotyne International.

What are Penny stocks?

As the name suggests, these stocks are generally traded for less than a dollar (penny) in United States while in India these shares are traded at below Rs. 10. If you saw the scene carefully, Jordan mentions that the share is trading at 10 cents a share.

These stocks are quite attractive as they trade at a very low price therefore they are appealing for beginners. In India, these stocks fall under the category of micro-cap and their market capital is low i.e. below Rs. 500 crores. Many Penny stocks are listed on National stock exchange (NSE) and Bombay Stock Exchange (BSE).

Advantages of Penny Stocks:

As you saw in the scene, it is quite possible that John (customer) Jordan is speaking with would be able to pay-off his mortgage.

  • Penny stocks are affordable as they trade at a lower price.
  • Penny stocks do give good returns if they make a bold move in the market.
  • They are not known to many retail investors, hence doing your own research would give you an edge.

Disadvantages of Penny Stocks:

Finite information is available about the company, thereby making it difficult to do a thorough research about the company.

Risky stock- These stocks are considered risky as they are easy to manipulate. If  1 individual were to buys a large volume, it would seem people are buying the stock.

Deregulated- Many Penny stocks have been deregulated. When companies don’t comply with SEBI guidelines, regulators can de-list it from the stock exchange.

Check-list for Investing in Penny Stocks:

  • Before investing, it is wise to thoroughly check the financials of the company.
  • Understanding the business of the company is a smart move. If you think it might not survive the competition or will collapse, listen to yourself.
  • Shareholding pattern- This information is crucial, if promoters are well known and are quite stable, one can consider buying penny stock of that company.
  • Invest smartly- Even if you have money to spare, be prudent to not waste your hard earned money. Less than 10% of your total portfolio can account for penny stocks.

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