Five years since pandemic crash: Penny stockholders celebrate, but for how long?

But even in this grim backdrop, headlines are often peppered with penny stock multi-bagger success stories, indicating an unsatiable appetite for these stocks.

The allure of humungous returns on minimal investment has driven many investors towards penny stocks—microcap companies with dirt-cheap share prices. Since these stocks are priced low, even a small increase in their value can result in a significant percentage gain in invested capital, and the pandemic bull run offered them the perfect opportunity to become ‘multi-baggers’.

A Mint analysis of penny stock behaviour during the last four major market cycles in 20 years reveals that in the latest bull run of 2020 to 2024, around 90% of stocks in the penny universe offered more than 100% returns, i.e. more than doubled, or turned ‘multi-baggers’. Stocks priced at ₹1-15 were defined as penny stocks in the analysis.

This stellar performance is second only to the one they put up during the 2003-2008 bull run when 97% of them turned multi-baggers. During both the bull runs, close to 90% of these stocks crossed the penny stock threshold by the end of the bull phase.

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This indicates that during good times, euphoria trumps logic, and heady valuations supersede fundamentals. As a result, penny stocks tend to generate wealth for the lucky and savvy investors during bull runs. But whenever the tides turn against investors, these stocks crash the hardest, wiping out huge chunks of their gains or straight-up plunging into losses.

Penny lane

At the end of the bear runs that followed the bull phases that were part of the analysis, 25-47% of the stocks that graduated from the penny universe returned to being penny stocks. Interestingly, in the ongoing correction phase so far, only 7% of such stocks have downgraded to penny status since the market peaked in September.

This is because the current market correction has not been that severe yet, despite how investors might feel, noted Umesh Gupta, fund manager and head of equity at Ambit Global Private Client. To put things in perspective, between 2008 and 2020, the market fell around 28-60% during the three major bear phases. The broader market has only lost 12% in the current phase and is not in full-blown bear territory yet.

“Usually, in the first few months of a market decline, these stocks do not fall significantly because the not-so-savvy investors lap them up at cheaper valuations in hopes of even higher gains in the near term. They see it as an opportunity rather than a warning sign,” said Gupta.

But if further bouts of correction follow, the value of these stocks usually keeps halving in every downturn, he added. Experts also pointed out that among the 93% of ex-penny stocks still wearing the multi-bagger crown, many have already corrected 50-60% in the latest downturn, further appealing to gullible investors.

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“A lot of young individual investors who entered the stock market for the first time during the pandemic have been the most interested in penny stocks,” Aman Dwivedi, head of equity advisory at HDFC TRU, told Mint. “Older, experienced clients usually stay away from these segments due to the high associated risks.”

Traditionally considered the fringe element of the stock market, the world of penny stocks is murky. Limited information about small businesses and extremely tight liquidity often create fertile grounds for promoter-led stock price manipulations and outright scam companies to thrive. Naturally, conventional investors have shunned this segment.

Buoyant markets

But the micro- and small-cap universe has also fundamentally improved a lot in the post-pandemic era, garnering a valid sense of excitement among risk-takers, noted Sandeep Raina, head of research at Nuvama Professional Clients.

“A lot of these small companies have strong business models where we have seen their market cap growing by 10x in just two to three years. There are tremendous growth opportunities in this segment if you can find them,” said Raina.

Promoter quality has also improved in general relative to the last small and medium enterprises (SME) boom in 2016, which instilled more confidence in investors during the latest boom, he added. Hence, the post-pandemic rally in penny stocks was more secular than other bull runs.

The government’s Make in India push through several production-linked incentive (PLI) schemes created a thriving ecosystem for new small companies after covid, said Gaurav Didwania, partner and fund manager at Qode Advisors, a portfolio management service firm.

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Hence, “these companies have seen their earnings grow 2-3x faster in the last six years, compared to the growth seen in the last 15 years. Naturally, the risk appetite for this segment also rose sharply after the pandemic, especially from HNIs (high net worth individuals),” said Didwania.

Moreover, buoyant markets also allowed these companies easy access to capital for restructuring and scaling up, creating notable winners in the infrastructure, real estate, renewable energies and utility sectors, said Dwivedi from HDFC TRU.

However, most experts cautioned that even though the broader pool has improved, investors are still locked in risky bets as further corrections will choke the exits from this segment. They also noted that while the latest rally has offered temporary relief to these multi-baggers, any more falls are likely to expose the cracks beneath the surface, and only the fundamentally sound ones will stand strong in the end.