BASICS FOR BEGINNERS .....

Multibagger stocks: Manage risks and reap rewards

Courtesy : Economic Times

Multibagger stocks: Manage risks and reap rewards

Stock investing is inherently risky. Little wonder that it's not recommended for those who usually want to play it safe. Still there's no dearth of brave hearts who, in a bid to maximize gains, are always willing to take that 'extra' or even 'unlimited' risk.

After all, as the saying goes, there's no gain without pain. And there are stocks available for this breed of people as well. The 'only' catch is that if they can make one a millionaire, they can make one bankrupt too! But not everyone is scared, at least not the risk seekers. Even with all the risks and drawbacks involved in such stocks, many investors simply find the potential windfalls well worth it. If you too are unable to resist the lure of big money, you can also take a chance. However, it is better to know the tricks as well as the risks involved before putting your hard-earned money into high-risk stocks.

Things You Should Know

The first question before venturing into high-risk stocks should be directed at yourself. Do you have the knowledge, temperament and resources to let you start investing in such stocks without seriously damaging your financial future? And exactly how familiar are you with these stocks and the way this market works? .The golden rule of investing is never invest in anything you don't understand. So, if you don't understand high-risk stocks at deeper layers, never take the chance.You also need to figure out the amount of money you are willing to risk investing in such stocks. In fact, you should limit yourself to that amount, and not a single rupee more. That way, even if the worst happens, you may be poorer, but you won't be destitute.

Get a Fair Idea of High-Risk Stocks

If you still consider them worth the risk, you should have some idea about these stocks, which include penny stocks, turnaround stocks and concept stocks.

Penny Stocks are of a company whose business failed and which does not have a revival plan to make it economically viable again. Because of the continuous erosion of shareholders' wealth, these stocks trade at low prices -- typically, between Rs 1 and Rs 10. However, since their levels are quite low, they sometimes represent great money-making opportunities with limited risk.

Turnaround Stocks are of companies which are not performing well for various reasons, including adverse industry fortunes, higher debt and higher interest burdens, accumulated losses, inefficient management or uneconomical size. However, when these companies go through restructuring or they see a management change, they can offer turnaround possibilities.

Concept Stocks are of companies that are likely to create significant value for investors in the future. Usually concept stocks trade at very high multiples because there are great expectations built into the future prospects of these companies. Organized retail, branded jewellery, wind power energy, security and surveillance systems, logistics, outsourcing and oil drilling are all concepts that are likely to have great demand going ahead.

Risks Involved with Penny Stocks

Liquidity Risk: Usually the major ownership of penny stocks rests in the hands of a few people like promoters of the company. If these people decide to unload a significant number of the stocks, the price drops steeply. Also, since most of the trades are speculative and not really backed by fundamentals, the moment there is a market correction everyone wants to get rid of these stocks, resulting in huge price corrections.

Trick Trades: Going by the past experience, penny stocks' prices are sometimes rigged and artificially inflated. Investors get sucked in looking at the price movement only to suffer later as prices drop when the traders offload large quantities of shares.

Corporate Governance: Most of the penny/small stocks are poorly managed and governed. Some of them don't even send their annual reports to investors!

Risks Involved With Turnaround Stocks

For these stocks, the turnaround may not sustain, leading to losses.
"The risk in turnaround stocks arises when a restructuring plan has yet to take shape, and only ideas are floating around. Normally, only one of 10 such companies will be successfully restructured, while the rest will be liquidated. Additionally, such companies carry a very low net worth on their books, and provide little cushion to equity investors," Dinesh Thakkar, CMD at Angel Broking, said.

Investors' Profile

Usually, retail investors/day traders invest in penny stocks are.

"These investors are risk seekers as they want usually high returns and, hence, are attracted to penny stocks. Sometimes greed and ignorance are the only explanation for some of these investments," T Srikanth Bhagavat, Managing Director at Hexagon Capital Advisors Pvt Ltd, said.Like penny stocks, turnaround stocks also bring in multiple returns, but investors in these stocks are convinced about the future profitability and are looking for high returns accompanied by some risks.

The conceptual style of investing is good in any market circumstance. However, benefits become more obvious over a longer time cycle.Therefore, relatively long-term investors looking for extraordinary returns are interested in concept stocks. Once these stocks come into the limelight, they generate healthy returns," Ashish Kapur, CEO at Invest Shoppe, said.

Precautions while Investing in Penny Stocks

Anyone new to investing in penny stocks should first be made aware of the differences between these stocks and the more conventional bluechips and midcaps.

"Unlike buying shares in a large, stable company like Reliance and SBI, you are dealing with speculative investments. Penny stocks and junk scripts look attractive to the investor when the indices are rising since the price of these shares usually rise faster than  the rise in prices of other shares. However, when the market falls, the investor is left with junk, which has no value," Kapur warned.

As a matter of principle, you should invest in only those penny stocks whose fundamentals are known to you. Also be prepared to hold on to these stocks till the market discovers the hidden value in them. You also need to diversify and never put all you money into a single stock, no matter how sure you are.

Precautions in Turnaround/ Concept Stocks

Often turnaround players report bumper profits after a "sad" track record. It is pertinent to understand the driving factors behind the profits. A savvy investor typically chooses companies that have started making profit at an operational level due to operational efficiencies and changing business fortunes. The company is in the first stage of turning around, though it is still in losses at the net level. There is a high possibility that it would make it to the net earnings level soon.

"As far as concept stocks are concerned, investors need to be educated about the conceptual style investing, as it requires commitment for a longer time from the investors. Also you need to have the ability to spot emerging trends in the social and industrial environment," Kapur said.

Identifying Multibaggers

Identification of these stocks is also far more difficult than large, reliable stocks. Picking these stocks, therefore, requires detailed understanding of their business and a vision to anticipate the future for the companies' business. It may also require an eye to discover the hidden assets in a deeply-undervalued company.

For instance, turnaround stories can be identified by closely keeping a watch on the concerned company, following its policies, results and other business activities. A close interaction with management and understanding of their decision making is also necessary. But these stocks come into light only after some of the turnaround has already happened and there are some signs of changes. Also, in such cases, the net worth of the company is generally eroded, and, therefore, one should look at the replacement value of the company. "This can be done by studying the company's EV to sales and comparing it with the industry average," Thakkar said.

Have Patience/ Conviction

Invest in these stocks only if you are fully aware of the risks involved and also know the market well. Whatever be the case, investing in theme/concept stocks requires patience and conviction.

"Patience because the sector/company which has tremendous value may take time to be noticed by the market, and conviction because without thorough knowledge of underlying value in the stock you will not be able to hold the stock for the period long enough for full appreciation to be realized," Kapur said.

Conclusion

Sure, these big prizes also mean the investor needs to be resourceful, have an upper hand on the information flow connected with the stock, and that means investing some serious time as well. An upside is that there are professional services available nowadays that can help big players with these investments. They may be in the form of private equity investment vehicles or hedge funds, etc..