Can penny stocks in the Nigerian stock market still make you rich?

Once upon a time, in a land not so far away, called the Nigeria Stock Exchange, people were known to have made their first fortunes investing in shares, particularly penny stocks. They went on to live happily ever after as the companies behind these stocks grew in size and stature and declared bumper harvests for everyone involved.

Even the budding newcomer who, in many cases, knew absolutely nothing about how to conduct proper analyses on company financials struck gold with, in certain cases, random stock picks.

There was euphoria in the land as many at the time liquidated their holdings and went on to live off their bullion load returns well into dotage, while some held tight to their shares and simply depended on the dividends they received from their portfolios. The jamboree went on for quite a while as next to anyone who forayed into this happy territory mostly walked away smiling, until, of course, a new horrible menace arose.

This menace came in the guise of con-artists posing as stock market traders with false links to insider information that could make you a bundle overnight, ponzi schemes promising far greater returns in shorter periods, global then local stock market crashes, government policies inimical to some of these companies financial sustenance, currency trading and crypto peddlers who came promising triple digit returns without risks, and in even shorter periods still.

And so began the mass exodus out of this land of financial utopia until its blissful memory was almost erased from peoples’ minds. Almost, that is, until a closer scrutiny of the Nigerian stock market returns over the last 5years, 2017–2021, revealed that the party might not have really ended. It just may have only lost a little steam, with eyes on a rebound perhaps?

With respective returns, year on year, of +19.5%, -17.8%, -14.6%, +50% and +6.7%, the NSE has surprisingly returned an average of 8.8% each year over the last half decade, despite double digit negative returns in 2018 and 2019 respectively, and added over 40% to investors’ capital over same period, surpassing average five-year inflation rate, 14%, by more than 20%.

Maybe not the anticipated bang for your buck you had hoped to read about, however, chief amongst the current success stories of the NSE till date has been penny stocks. Amongst the top 10 best-performing stocks for 2021, at least six of these were considered penny stocks with all of them returning well over 100% in just 12 months, Morison Industries Plc, being the highest gainer with a whopping 306% returns.

Penny stocks, as the name implies, are investments that can be considered cheap, or in the Nigerian context, can be bought at several kobos to a Naira. Considered high–risk due to relative small market capitalizations, they sometimes lack sufficient financial history and information, and predominantly have low liquidity, coupled with relatively low financial earnings per share (EPS), plus their susceptibility to even the smallest stock market volatility and, or, manipulations, makes them even riskier investments.

On the flip side however, one great advantage of penny stocks, is your ability to build a diversified portfolio without a large capital outlay and their insanely rapid ability to gain in price valuation, sometimes within weeks, or even days. This thus makes them excellent growth stocks, if you can single one or two potential winners out of the herd with some promising undervaluation then you are well on your way.

With that said, and with the telltale signs of last year already presenting a rebound, let us take a look at how to make positive gains in 2022 on the back of penny stocks.

First and most important is information. You cannot make informed buying decisions without requisite information to base projections on. Thus, choose a company with more than sufficient information, more particularly on the internet, about their business, directors and financial reporting. It may be of some inconvenience if you have to always place a call to your broker or take a walk into the company’s premises requesting financials ever so often. Lack of information is extremely risky.

Choosing what industry the company involves itself in is also critical. Some business industries generally tend to do better than others for varying reasons, mostly due to liquidity. Cash is generally a critical pivot. Thus, unless through mismanaged funds, companies that tend to have a lot of cash to play around with and are somewhat independent of volatile government policies or can easily pass on the extra taxes or local/federal charges to their end consumers, tend to be sustainable investments.

Also, as earlier stated, stock liquidity can be a major issue. It would be useless to want to buy into a company and be unable to owing to too few shares to buy. It is thus advisable to not only research how many shares the company has in issue, but also critical to know proportions owned by the general public and traded daily.

Institutional investors tend to hold on to huge chunks of their investments in certain companies for prolonged periods of time. Such situations can be double edged swords. They ensure some equilibrium in the company’s share price but a selloff by the same institution could spark a panic, seeing prices crumble, and very quickly. The reverse is also true.

A look at the company’s daily trade can offer sufficient information to go by in this regard. Too few shares being traded in any given period of time compared to others, possibly within the same industry should spark caution. You do not want to be stuck with equities nobody is interested in buying when you wish to sell.

Be critical with the financial reports. Many a novice have gone wrong with their inability to ably read the fine lines between company financial figures to have a clear idea on how the company makes money and if its business model is viable. If you have found a stock that may look interesting but cannot tell heads or tails between its figures, perhaps it’s time to take an online course or approach a mentor.

Look for consistency. Though traded by the pennies, some companies with, albeit, small capitalizations are surprisingly very well run. They deliver consistently to investors and the general public and regularly report their financials as compared to others.

Companies that have a diverse portfolio of products and services to sell to the general public are also great buys. Mono-product companies could be wiped out in a day, should people no longer find their product worth buying. Study the companies closely to know how well their brands or products do in the market and take a cue from there.

Compare and contrast financials within industries, not without. Companies within the same business industries typically have the same principles affecting their financial statements than those outside. It’s thus best, when cherry picking penny stocks, to compare those within the same industry and not outside. As the saying goes, ‘the numbers never lie,’ do not then be surprised to find that a company, though small cap and reeling in small figures in terms of gross revenue, may post better than average ratios in terms of such indices as Liquidity Ratio and Return On Assets Employed (ROAE) than even their larger cap peers.

Be cautious of excessive dilutions. Stock dilution refers to loss in common share value caused by a deliberate increase in the number of units of a company’s equity ownership, oft times through bonus share issues. Think of it as whiskey that has been made less concentrated when water is added. And just as with basic economics, the more stocks of a company become available to the general public, the less possibility of a rise in share price. This can sometimes be caused when the directors wish to raise funding by selling their shares to existing or new shareholders or even both, so they create more.

A need for funding could mean the company has been running on fumes and needs to fill the financial tank before everything tanks. If you have already bought into such companies before a dilution, it is best to find out what the funds will be used for and then act accordingly. If the directors however have chosen to reward investors through a bonus share issue rather than monetary dividends at the end of the fiscal year then perhaps it’s best to give your stockbroker a ring. Selling off before the share price possibly tanks may still leave you with enough to lick your wounds with and perhaps try again with another company or even the same when some form of stability in the company, its financials, and its stock price presents itself.

If you however are in for the long haul, which in most cases is best advised, then selloffs may be ill-advised as traditionally stocks tend to do much better over time than in the short term.

Thus, when it comes to making money off penny stocks, it is best to find as much information about the company as possible, carefully read through financial reports, going as far back as five years to get a clear understanding of how it has fared. Compare and contrast financials within industry and keep an eye on periodic stock trade numbers, preferably daily, and the intricate numbers reported in quarterly statements. Choose companies whose industries tend to be resilient to fluctuations in government policies or seasonal buying and usually have positive cashflow. And stay away from mono-product companies.

Brain Essien is a business consultant, with expertise in crowd funding and business plan/proposal formulation and design, working and living in Lagos State. +234703-444-6041

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