Karnataka Elections impact: As Sensex, Nifty bleed, investors tap penny stocks; should you invest?

The qualified win by the Bharatiya Janata Party (BJP) in Karnataka elections has failed to cheer investors on stock exchanges, as both benchmark indices Sensex and Nifty 50 are falling since the start of Wednesday’s trading session. It was a dramatic comeback for the Congress in this state’s election which was held on May 12, even though it lost the poll to BJP. The results indicated a triumph for the Bharatiya Janata Party (BJP) as they are now leading with 106 seats, and Congress with 75 even as JDS has bagged 39. However, the party has not been able to get a simple majority to ensure it gets to form the government. This has led to selling pressure in Sensex and Nifty 50 so much so, that they have given away over 300 points and 100 points respectively so far in a day. 

At around 1523 hours, the Sensex was trading at 35,402.27 down by 141.67 or 0.40%, whereas Nifty 50 slumped by 53.45 points or 0.49% trading at 10,748.40. 

Interestingly, where investors fled on stock exchanges, there was a rally in penny stocks, which witnessed a jump in the range of 2% to a massive 18% today. 

Penny stocks are also one of the investment tools on stock exchanges, which are available at very low prices and have low market valuation. They are offered in the range of Re 1 to Rs 10 and have a market value less than Rs 100 crore.

Today on benchmark indices, a list of 8 penny stock saw massive uptick in their prices, including even Mehul Choksi’s Gitanjali Gems - he recently fled abroad following the Punjab National Bank (PNB) scam that is worth Rs 14,000 crore. 

Share price of Gitanjali has risen by 4.96% on BSE, and touched an intraday high of Rs 4.44,whereas on the same day PNB share price has slumped by nearly 12% on the index, after posting a weak Q4FY18 financial performance. 

Among other penny stocks that gained are Lycos Internet by 4.82% with an intraday high of Rs 5.44, followed by Cranes Software International by 4.79% with day’s high of Rs 1.98 per piece, Suzlon Energy by 4.78% with high of Rs 9.2 per piece, Jaiprakash Power Ventures by 3.61% with high of Rs 3.73 per piece, Educomp Solutions by 3.53% with intraday high of Rs 4.4 per piece and Ferro Alloys Corp by 2.47% with intraday high of Rs 5.8 per piece. 

It was Gammon Infrastructure Projects that saw a whopping increase in their valuation by 18.36% with an intraday high of Rs 2.45 per piece. This company’s share price has also become top gainer on overall BSE index in terms of percentage. 

Investing in penny stocks is very interesting, there are few odd gems among them which can provide heavy gains right from 100% to 3000% if identified correctly by investors. 

When FY18 began, it was known that there were over 1,800 stocks on the BSE which were trading below Rs 10 and have delivered up to 20,000% return over the past seven years.

The reason for adapting this platform is very simple, investors believe that  a stock trading at Rs 3 has higher chance of becoming Rs 30 - giving over 10 times return, in comparison to the stocks quoted at Rs 300 which they find it harder to become Rs 3,000.

While investing in penny stocks, one forgets that every company, which has low price, will not provide you high value.

Investing in penny stocks is like gambling, because you are betting your money in a company with no fundamentals in the hope of earning higher returns.

These stocks are highly speculative stocks of small companies which have limited cash and resources. They often have high-risk investment with low trading volume and less attention from investors.

Last year a study by ICICI Direct said that there is only a 42% chance that an investment in penny stocks will yield returns, that too if you can hold it for at least three years. On the contrary, 86% of stocks priced above Rs 1,000 made money for investors in the past three years.

First risk that arises in penny stocks are they do not have a proper fundamentals, and also investors have no access to accurate research reports. Secondly there are traded at extremely low volume of shares which means they are easy target for unscrupulous operators to manipulate the price of the stock by cornering a large quantity of the stock and sending the price to soar or dumping a large quantity and compelling the price to plunge.

Also one factor that a person needs to keep in mind while investing, is that most of them trade at very expensive valuations and some do not even have a PE ratio.

Penny stocks are often used by their operators, stock brokers and owners for  raising bogus long term capital gains and tax benefits. Therefore, these penny stocks get delisted as they are always under the scanner of market regulator Securities and Exchange Board of India (SEBI) and IT-department.

In an probe report submitted by Sebi in 2015, the income tax department by end of FY17 has identified about 64,000 entities which evaded taxes to the tune of Rs 38,000 crore in penny stocks. Recently, the Prime Minister's Office  has reportedly apprised the Central Board of Direct Taxes (CBDT) of 80 penny stocks.

So if you are think of investing in penny stocks, check that the company must have a business of a few years with promoters holding reasonably 30-40% minimum in these stocks.