Risks involved in penny stocks.

Risks of Penny Stock Trading

The investing adage "buy low, sell high" is good advice. There's nuance to it, however. "Buy low" doesn't mean "buy the cheapest stock possible". Similarly "sell high" doesn't mean "wait for it to become the most expensive stock possible". In this context, low and high are relative terms which refer to the underlying value of the business itself: buy when it's undervalued and sell when it's overvalued.

Novice investors commonly look for extremely cheap stocks, figuring that a stock selling for Rs 1 has a lot more room to double or quadruple in value than a stick which sells for Rs 10. Novices commonly fall into the trap of looking for penny stocks to buy. This is risky, but you can avoid this.

What is a penny stock? It's a stock that generally sells for less than five dollars per share and trades outside of a major exchange. These stocks are cheap for a reason: they usually belong to companies in bankruptcy or other financial troubles. These stocks are popular in certain circles, but they're very risky. You might also hear them referred to as microcap stocks or pink sheet stocks. It's all the same thing.

Why Do People Get Started Trading Penny Stocks?

A cheap stock may seem on the surface to give you good value for your money. If you ten thousand rupees, you can buy 20 shares of Tata Motors at Rs 500 and 20000 shares of some random stock selling for Rs 0.50. Which would you rather have twenty shares or twenty thousand? Psychologically speaking, it seems like it's easier for something selling for Rs 0.50 to go up to a Rs 1 (doubling your money) than it is for Tata Motors to go up to Rs 1000 (doubling your money).

The problem is that the value of a stock depends on two things. First, its value is whatever someone's willing to pay for it. With millions of shares changing hands every day, millions of people are judging what stocks are worth. Two, the value of a stock depends on the value of the business behind it. It's much better to own a company that's making money than it is a company that's losing money. People are willing to pay a little more for the privilege of owning part of a successful business than they are to own part of a failing business.

Most of the time, a stock price below a dollar means that people think the business is in trouble. Most of the time, they're right. Even if you've found likely candidates, penny stock trading is one of the riskiest types of investing.

Struggling Companies and Buyouts

It gets merged with another company. Sometimes that happens, or sometimes a stock gets bought out entirely. In that case, the acquiring company will often make a bid for the troubled company, based on what they think the company is really worth. That's probably the value of the assets: real estate, inventory, existing contracts minus existing liabilities.

In the case of an acquisition, the acquiring company may either pay existing stockholders a fixed price per share or convert shares of the acquired stock into shares of the new parent company at some ratio.

Sometimes this is a good deal. Sometimes it's a fair deal. Any profit you make depends on the price you paid. If it's below the acquisition price, you might make a little profit. In this situation, timing is everything. You have to buy the stock for less than what it will sell for.

How do you know what it'll sell for? You have to figure out what the company as a whole is worth—its inventory, any existing contracts, any investments, the value of real estate, and the opportunity costs of acquisition. That's a lot of financial analysis for a company that'll probably go bankrupt.

Selling Penny Stocks is a Difficult Task

Of course, to buy a stock at the right price, you have to find someone to sell it to you at that price. That's not easy. Unlike a normal stock, where people buy and sell based on actual value of what the company can actually make, penny stock trading relies on speculation. Everyone who owns the stock is waiting for it to turn around somehow. Maybe you'll get lucky and someone who bought it for Rs 0.20 a share is willing to unload a few thousand shares at Rs 0.50 a share, but it's more likely that anyone who bought it wants to make 10 or 20 or 50 times profits.

The same goes for getting out of a stock. Sure, you bought it at Rs 0.25 a share and good news has raised it to Rs 0.50 a share, and you think you're as lucky as you're ever going to get, but are there enough buyers at Rs 0.50 a share for you to sell all of your shares?

Penny stocks have very little liquidity. There aren't many buyers and sellers because they're so risky. Unlike a share of Reliance stock you can buy or sell pretty much anytime near the asking price, there aren't enough buyers and sellers who agree on prices, so their prices have wild swings. You're going to have to have great timing and even better luck to sell at the price you had in mind. That's after you've gone through all of the hoops in How to Buy Penny Stocks.

Sure, you can wait for the company to turn around—but most don't. Most don't get acquired. Most go out of business.

If you're looking to get rich while day trading penny stocks that lack liquidity, will work against you. If you're at all ethical—if you're not defrauding other people with pump and dump scams—you're relying on luck, and luck is a poor investment strategy. As well, patience works against you. You have to race around the clock before these poor companies go out of business altogether. That "hot penny stock tip" you just saw in email? That's someone's desperation trying to trick you into buying what he really wants to sell.

People often ask where to buy penny stocks. You can generally buy them through any reputable stock broker, though you'll likely have to sign a disclaimer that you understand the risk of smallcap trading. In shadier corners of the Internet, you can find businesses which purport to specialize in these trades, but trust may be an issue. Any reputable stock broker will have to run you through several pieces of paperwork to ensure that you understand the risks of this type of investing.

Shifting focus

As Mr Shankar Sharma said on CNBC and it is also apparent that the large caps haven't been as profitable in the recent times as much the small caps and mid caps have been. The large caps especially companies like Reliance, Tata, Infosys, TCS etc have established business but haven't seen much growth in the recent times. There wern't much rise in the earnings, rather there were reduction in earnings of some. In many companies the share prices also haven't gained much. While when we have a look at lower capital companies ie the mid caps and the small caps, we can see that many companies have been growing consistently and posting good results.
Shifting focus from large caps to small and large caps will be quite profitable. Hedging of risks should be done.However putting all eggs in one basket wouldn't be a prudent policy. Proper balance between high risk and low risk stocks should be maintained as per the risk appetite. Diversification protects from the threat of making huge losses due to downfall of a particular sector or similar bad news. Large caps do not have much risk but they haven't witnessed much growth in earnings as well as share prices. On the other hand small and mid caps have been giving multiple returns. Many have multiplied 3x 4x 5x within decent time period. 

Now in the coming time, we might see some small caps turning into mid caps and mid caps into large. The big companies largely are expected to remain stagnant except a few who have entered new horizons and the ones in pharma with good operating efficiency. Speaking about about long term now, one must go for fundamentally strong small cap companies operating in hot sectors like infra, defence, logistics, digital marketing, PEB products which is a gift of the Make in India concept introduced by PM Shri Narendra Modi. These sectors are expected to have a great future ahead.
Finding out gems from a big pile of stocks isn't everyone's cup of tea. It requires knowledge, analytical skills and last but the most important factor which is patience. But it's isn't that difficult too, what is important is sticking to the basics and applying them properly.
In finding out great picks, value investing and fundamental analysis together work the best. They help in finding out good picks. Fundamentals go a long way in deciding the company's future in the longer term which is a period of not less than 18 months atleast.
Long term investment in stocks gives mind boggling returns and is one of the best return giving investment over all others including gold, bonds, property.
Finding out your growth pick and sticking to it, that's what is required in Stock market.
Go long, stay invested.
Details about Value investing and fundamental analysis will be posted on the blog in the coming times which will help in finding multibagger of the future.
Share the knowledge everyone.
Happy investing.

The pillars to successful investing

The Five Pillars To Succeed As An Investor

From my experience in stock market, and from my readings of the world’s greatest investors, I have learnt that successful investing (that makes you rich while keeping you sane) depends on just a few factors.

These are the cornerstones of how to sensibly invest in stocks, using everything I’ve learned.

The Business
A stock is a share in a business. Repeat it! A stock is a share in a business.

A stock is not a piece of paper like speculators and traders treat it as. A stock represents part ownership in a business. Benjamin Graham, the father of value investing, wrote that ‘investment is most intelligent when it is most businesslike’.

This is a statement which Warren Buffett has regarded as the most important words about investing ever written.

Circle of competence
‘Do what you are best at’ is one important advice that every teacher gives her students. This is exactly what the teachers of value investing will tell you – never stray outside your circle of competence…outside what you know.

In simpler terms, you must invest in a company whose business you can understand with ease. Great investors have become great by following this very principle of ‘circle of competence’. And those who did not give a heed to this, their poor stock market returns speak for themselves.

Intrinsic value
“Price is what you pay, value is what you receive,” goes the famous saying. We employ this in everything we buy. And we almost never pay a price that we believe is higher than the value a thing provides.

But this principle is rarely used when it comes to investing in the stock markets. Value is rarely considered a determinant of the price most people pay for stocks they buy.

It is a bad policy to not consider the value of a business before buying its stock.

Mr. Market
Stock prices fluctuate, sometimes wildly. Some of these fluctuations aren’t bad! In fact, these provide the sensible, value investor a good hunting ground to identify quality stocks at throwaway prices.

As Buffett once said, “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”

Margin of safety
These are considered the three most important words in investing.

Margin of safety is simply the difference between the intrinsic value of a stock (or the core value of its underlying business) and its market price. It suggests that one should buy a stock only when its intrinsic value is worth more than its price in the stock market.

The key advantage of using margin of safety while investing is that it minimizes the chances of permanent loss of capital. You must include the margin of safety principle in your investing to preserve your capital.

Bringing It All Together

Each of these five pillars of value investing enhances the others. Together, they’re much stronger than they would be if any of the pillars were missing.

PRACTICING PATIENCE

The toughest thing for many investors to do is nothing. That’s right, nothing! Once you buy a stock and watch it move up, down and all around for a few weeks, there is an urge to take action. Since you bought the stock, you’ve probably read numerous investment news stories on the market in general and your stock in particular. And even if you are only watching your stock (as we advise), you’ve taken in many days of price, volume and relative performance (RP) action. With so much input, it’s easy to have your thinking swayed, which creates temptation to take action.

Another way to say it is that most investors lack patience. That’s a shame, because almost every successful investor we’ve ever met or read about has an abundance of patience. After all, if you’re correct on a stock, what’s the point of rushing things?

So the focus of this lesson,  dedicated to holding great growth stocks, is on practicing patience. Many times, the stocks you purchase don’t do an awful lot for many weeks after your initial purchase. But if you have the guts to stick with those stocks, some can turn out to be huge wonders. And in the end, those big winners are what make all the difference.

Making Money the Easy Way—By Doing Nothing!

Here’s a quick tidbit that most investors forget from time to time. The way you make money in the stock market is by holding stocks, not buying or selling them. Sounds obvious, doesn’t it? That’s just the how the stock market works. The value of your portfolio rises when a stock you own rises. So you have to be holding on to a stock if you’re going to take advantage of its appreciation.

The following excerpt is from Reminiscences of a Stock Operator, a fictional biography about the investing life of Jesse Livermore. In it, his character, Larry Livingston, expresses the principle of practicing patience as eloquently as we’ve ever heard:

“And right here let me say one thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It was my sitting. Got that? My sitting tight! Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money.”

But I urge u is have patience once you’ve committed money to great growth stocks. Often times, a stock will start moving ahead just after most investors have thrown in the towel. Don’t be one of them!

The message is simple: Practice patience and give your investments a chance to grow into mighty oaks.

What’s Your Goal?

When buying great growth stocks, your goal for every purchase should be to develop a huge winner. By huge, we’re not talking about 30%, 50% or even 100% profits. Instead, you should set your sights much higher—300%, 500%, 1000% profits and higher. All you need is a couple of these big winners every year or two to produce spectacular portfolio returns.

That last point is an important one: All you need is a couple of these big winners every few years to produce spectacular portfolio returns. Knowing this, you shouldn’t agonize over a few small losses, or worry if your last few purchases haven’t turned out the way you had hoped. Instead, by shooting for big profits, you put yourself in a position of power, only needing to find a couple of good stocks to produce great returns. Contrast that with the investor who’s eager to take any profit he can get his hands on. He must find perhaps ten stocks each year that show him good (but not great) profits to garner the same returns you’ll attain by getting only one or two huge winners.

This is why I never use target prices for growth stocks. When you set a price target, you’re automatically limiting the profits you’ll take out of any one stock. And that’s something we will never do!

Finally, remember that if your goal isn’t to develop huge profits, you’ll never attain them. So aim high!

How Practicing Patience Leads to Huge Winners

Clearly, you cannot develop wonders without practicing plenty of patience.

For example, let’s say you buy a stock and watch it double. Great! You now have a 100% profit. Now assume your stock works its way still higher, doubling again. After your second double, your profit expands, not to 200%, but to 300%. A third doubling would yield a 700% profit. And a fourth would give you a whopping 1500% profit. It’s not impossible to attain these huge profits. Believe it or not, dozens of stocks have grown many-fold in just the past two years. Whether or not that type of growth will happen again is anyone’s guess. But the fact is, the market provides a never-ending stream of opportunities for  investors like you.

WIPRO shares- If you applied for and were allotted 10 shares at Rs 100 per share during the Wipro IPO in 1980, you would have paid Rs 1,000. And if you held on to your shares, today I suspect you would have no regrets. After bonus and share splits, you would own 960,000 shares today: and those shares would be worth Rs 537.6 million. That translates to an annualized return of near 46.5% (excluding dividends) over 34 to 35 years. Nice! And Wipro is not particularly expensive today.

This is just one of the big multibaggers.

You just have to have the guts to stick with your winners. Shares are risky but only when u trade. Investment in a potential growth stock will reduce the probabilities of reduction of principal while your investments might fetch you huge returns.

More on how to invest and where to invest will be posted in the coming times.

Happy Investing.

"WHY INVEST IN SHARES"

Studies have proved, time and again, that shares (or equities) are one of the best long-term investments in the FINANCIAL market place. They tend to outperform government bonds, corporate bonds, property and many other types of asset. 

Share prices can go down as well as up so buying shares is not without risk, but over the long term, they can generate good returns. If you want to double your money in a year, for example, buying shares is not the best way to do it. But if you want to invest for three to five, shares may be a rewarding investment.

Shares are designed to provide investors with two types of return, annual income and long-term capital growth.

Most shares offer income in the form of dividends, which are typically paid twice a year. Dividends can be seen as a reward for shareholders. They are paid when a company is profitable and has cash in the bank after it has satisfied all its obligations.

In most cases, the more profitable a company is, the higher the dividend payments. If a company is making substantial amounts of money and making significant dividend payments, it is usually considered a good investment so the share price rises.

Investors may buy shares specifically for income. Many companies generate substantial amounts of cash every year. They may use some of that money for general corporate purposes, such as paying rent and wage bills, and they may use some of the money to invest in equipment, research and development. But a proportion of that money may be paid to investors as a dividend. As dividends are usually paid out twice a year, they can provide investors with a regular income.

Companies that pay generous dividends are known as income stocks.

Some companies have heavy investment programmes so they plough their profits back into the business. These companies are often at an early stage of their development and they are keen to expand and grow. They are known as growth businesses and, if their plans succeed, their share price will increase substantially. 

Long-term capital growth comes about when a share price increases over a period of time.