PENNY STOCK VS BLUE CHIPS

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Penny stocks have come under the spotlight again. Active trading, especially among the penny stocks, saw the 10 most-active stocks on Bursa accounting for about half the traded volume of shares. The selldown in selected penny stocks spooked sentiment, as the number of losers outpaced gainers at a ratio of three-to-one, but that did not deter the buying of blue chips. The FTSE Bursa Malaysia KL Composite Index closed up 6.73 points to 1,878.89 20 August 2014. Week-on-week, the blue-chip benchmark FTSE Bursa Malaysia KLCI (FBM KLCI) added 6.68 points, or 0.36 per cent, to 1,870.99, with gains on CIMB Bhd (+20 sen), Tenaga Nasional Bhd (+18 sen), Public Bank (+18 sen), Sapura-Kencana Petroleum (+12 sen) and UMW Holdings (+58 sen) representing most of the index’s rise.

Penny stocks and blue chips are basically opposites, but there is no guarantee that either one is a great investment at a given time. Investors must always be careful when buying any kind of stock. Investors sometimes have the misconception that penny stocks are cheap and therefore will eventually have upside potential. A low share price does not actually mean that a stock is cheap. Only by researching a company's earnings reports is it possible to determine whether a stock's current price over- or under-valued.

Penny stocks usually refers to shares that cost less than RM1 apiece. Penny stocks often belong to newer companies with little operating history and tend to be small-cap or even mini-cap stocks. They are usually indicated with an .OB or OTC (over-the-counter) after the stock symbol, which means that their shares are not traded on the major exchanges. The price movements of penny stocks are usually driven by news of corporate action, contract wins, new business ventures or entry of prominent shareholders or management. To attract investors, they need to spin a credible story of impending corporate action which is done through all known of media (newspaper, word of mouth, social media, etc.). Penny stocks can be difficult to trade because of low liquidity and volume issues, but they can still attract investment capital from certain types of investors. Penny stocks are a very risky investment and there is no guarantee against bankruptcy, but they represent an interesting opportunity to speculators who benefit from the incredibly low share price and the potential for enormous upside. If the penny stock rises to 20 sen from 10 sen, traders make a 50% gain. The prospect of putting a small amount down for large upside potential tends to make people miscalculate or even ignore the risks involved. On the other hand, there are penny stocks that have extremely low trading volume, or are highly illiquid. Existing investors will find it difficult to sell their shares, especially when the price is on a downtrend.

Blue chips, like in poker and other card games, are the most expensive chips. Blue chip stocks are the most valuable stocks on KLSE and are usually from companies that are household names, such as and tend to be large or mid-cap stocks. Blue chips have a long operating history, steady earnings, and a good reputation. They also have high liquidity, or the ability to trade large amounts of a stock without any problems. Blue chips are considered safe bets, especially if the market is falling. However, some blue chips do not always perform well. Blue chips are able to attract institutional funds, thus most are covered by research houses and are often reported in the media. The trading price of blue chips seldom surges, unless there are corporate developments. Blue chips are less attractive to retail investors since the trading prices may reflect the value of the companies. Although blue chips are less risky than penny stocks, their trading prices will also be negatively affected during a financial crisis. However, blue chips stocks are the fastest to recover after the crisis. As for penny stocks, it will take longer for the prices to rebound.

The strategy of picking penny stocks is completely different from choosing blue chips. Buying penny stocks can be a form of diversification for investing portfolios, due to their relative affordability. Investors can own a portfolio comprising penny stocks from different sectors. Retailers usually have a smaller amount of funds to invest. With the same amount of money, they can buy more units of penny stocks than blue chips. For a retail investor or trader, finding the right penny stocks means they have to do their homework, since it is hard to find analytical data and research on these stocks, as they are widely covered by research houses. The lack of interest from institutional investors and foreign funds is the reason why penny stocks are not well covered or not covered at all by analysts. Penny stocks seldom pay regularly. Some penny stocks may not have the attention at the early stage, which enable its share price to rise. Meanwhile, avoid “hot stocks” with large trading volumes and no fundamentals to justify their trading price. It can be risky to invest in these stocks as they usually do not stay hot. Investors who can stomach the risk should still limit this to a small amount in their portfolio. For those inclined and are fully aware of the risks, they should set aside no more than 10% to 15% of their portfolio for such a venture.

The same practice is needed when investing in blue chips. A five-year horizon as investors cannot expect quick gains from blue chips. Blue chips are generally less risky than penny stocks as the share price is supported by fundamentals. Investors have to keep abreast of what is happening in the company and conduct research on the company, and look into its shareholders’ funds, debts, net tangible assets, cash flow and other financial information. A stock can be trading at 90 sen a share and be considered cheap. This is because for that one share, the shareholder is entitled to a fraction of the building, a portion of the cash in the company’s bank account and some of the inventories in storage, which are worth. It is important to make sure the company has a legitimate, viable and sustainable business. The longer its track record in running its business, the better it is for the investors. One should make sure one is not overpaying for the company’s business. The cheaper the investors can get these companies relative to the assets they own of the fair value of their business, which also means the greater value of the shares held.  People should be wary of companies with a lot of debt. When the share price is trading at a significant premium to its net assets, and to what the business should be fairly valued at, then it is high time to get out.