Penny Stocks Can Be Volatile
Penny stocks or what Ben Graham would have called low priced common stocks have a seeming arithmetic advantage in a sense that their prices can go up and down in a large manner percentage wise as compared to non penny stocks. However, as I have mentioned before in other articles, there is a need to be more discerning when it comes to penny stocks, or these low priced common stocks.
Penny Stocks In 2 Categories
There are 2 categories of penny stocks in my mind. One category is a category devoid of all fundamentals and are over valued. They trade at highly speculative prices relative to their turnover, assets, book value and free cash flows. Some are even perpetual loss making entities that never seem to see the light of day. Investors who want to invest in penny stocks should consider if an investment is speculative or indeed a sound one. A sound investment has a imputed margin of safety that would make sense whether it is a penny stock or not. Consider this. Imagine a penny stock trading at 1 cent per share but has a property backing of 10 cents per share and has not debt. Such stocks can indeed be found in the markets. The question is why some of these stock trade at such incredibly low prices. The answer can be attributable to several causes.
In the first place, many of these penny stocks or low priced common stocks do not have any analyst following them and they are also a segment ignored by many institutional investors. And then, if there are short term problems in some of these stocks are characterized by temporary losses or negative one off events, these stocks tend to depart from their true fundamental values. They are often the first to be sold when a recession or an industry downturn occurs. In other words, it takes a hit before many of the large cap, well known issues do.
So when an industry experiences a cyclical downturn, in the absence of speculators driving up prices, reputable coverage from research firms and a decline in institutional ownership if any, one will see large draw downs in the price of the security, percentage wise.
Of course, in instances such as the above, the more astute investors seize the opportunity to make investments into those with a sound fundamentals and have an intrinsic value higher than that of the price of the stocks.
I have benefited from investing in penny stocks or low priced common stocks but I have to say that they come with tremendous volatility. But all I need is that my average buying price be a lot lower than my average selling prices when industry or economic conditions are more prosperous. I am willing to stomach that short term volatility profit from a basket of such stocks. Again, I am using the law of large numbers, an idea borrowed from statistics.
And the other category of penny stocks or low priced common stocks are those which have a price that is well below their intrinsic value. They are often trading at low prices to the assets, book value, earnings, cash flows and turnover. My favorite of course are those that are trading at low prices to the net current asset value, those that trade below liquidation value. There are many merits to that that I have spoken fondly of in other articles. But by and large, asset values and balance sheet values fluctuate a lot less than earnings and cash flows.
Earnings on the other hand can be quite volatile. My view is to protect the downside first. A stock trading at prices less than the liquidation value which have a fair prospect of things turning for the better is already trading at bargain ‘floor’ prices in my view. Combined with very few investors interested in owning such stocks, the upside can be greater than the downside with some discernment on the investor’s part.
Some Examples Of Penny Stock Volatility
This company is a company called Nico Steel traded on the Singapore Stock Exchange. As you can see, the one day price movement resulted in a 25% spike in price. Just on 1 day. So this is typical of penny stocks. Be mindful that the price could move 50% downwards in any given day as well.
This is another company classifiable as penny stocks or a low priced common stock. You can see a 6.25% movement in a stock price in just 1 day.
Now, I have said this before and I will say it again. You always have to pick baskets of such stocks and not rely on any single stock for your portfolio performance. In other words, holding concentrated positions is not for the faint of heart! The volatility can cause sleepless nights especially for those who are amateurs in investing. I have to add another point here. You would have to be somewhat detached and not look at the prices of these securities daily.
In any case, play safe, learn more about it and decide if this is for you. As always, may you be blessed with prosperity, health and happiness!
These books which I have written are case study driven and discuss strategies, mindsets and situational approaches to employing the net current asset value strategy.
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