Run on penny stocks impacting portfolios

Thursday, 27 October 2011 03:43 - - {{hitsCtrl.values.hits}}

By Dinali Goonewardene

Runs on penny stocks have caused investors to divest blue chip counters, posing questions on their impact on the All Share Price Index in recent times.

“The rise in penny stocks has had a mixed impact on the indices. The rapid rise of certain penny stocks during the last few months have resulted in certain investors exiting blue chip counters in order to invest in these penny stocks, this has had a negative impact on the indices,” researchers from SC Securities said.

However, the rapid rise in the penny stocks also created a livelier atmosphere in the market, which helped activity levels improve, they added.

Earnings reported by penny stocks do not support their changing prices, but are sometimes the result of news of prospective developments which could result in improved earnings.

Blue Diamonds (Voting and Non Voting shares), E-Channelling, SMB Leasing, Tess Agro, Seylan Developments and Nation Lanka Finance are some of the stocks that have been moving in addition to fundamentally-sound companies or companies such as Piramal Glass, which are backed by earnings.

“It is important that investors diversify their portfolios to include penny stocks that are fundamentally sound (e.g. Piramal Glass). However, looking at today’s context, it seems an investor could benefit by having a small exposure towards even the penny stocks that are not fundamentally sound, in order to take advantage of the current situation, where penny stocks have the tendency of rising rapidly, especially the low cap (illiquid) penny stocks,” researchers from SC Securities said.

The rise in the price of penny stocks has helped the share market by enhancing activity levels and promoting a positive sentiment among investors, just as what we have seen during the past few months, they said.

“However, if the rise in the price of penny stocks that are not supported by fundamentals attracts a broader base of investors during a considerable time period, it could affect the market negatively as the blue chips or high cap counters will not be sought after which are fundamentally sound, the performance of which directly affects the indices,” SC Securities said.

Another brokerage which did not wish to be named said that penny stocks are low caps, hence it has a minimal impact on the All Share Index as it is a value weighted index. They said that when building a portfolio it is necessary to include different types of stocks such as value, growth, cyclical, non cyclical, etc., representing different sectors to gain the maximum returns while minimising risks.

Even though it is not a must, investors can include penny stocks which match their investment appetite to their portfolios. Most of the time, penny stocks can be chancy and are considered riskier.