Malaysia: How To Build A Safe Penny Stock Portfolio – Part 1

A Fool And His Money Are Soon Parted?





The frenzy continues. According to a report on the theedgemarket.com financial site, the local share market marked a new milestone last Friday as trading volume surged to a fresh record high of 11.81 billion shares, driven mostly by a rush for penny stocks.

This resulted in a total trading turnover of RM4.36 billion across the local bourse. Notably, the report said that this new record came just less than two months after the previous record high of 11.21 billion shares that was registered on May 18.

The brisk trading seen among penny stocks, which are often prone to speculation, resulted in the top 20 most active counters across Bursa Malaysia on the day being of the penny variety. And 17 of them were trading at less than 30 sen apiece.

A dozen of these counters were ACE-listed ones, which contributed a total trading volume of 2.92 billion, or almost a quarter of yesterday’s overall trading volume.

The report said that market experts thought the surge in trading interest was due to the current low interest rate environment, which rendered conventional fixed deposit yields unsatisfactory. Hence, more and more investors have been seen shifting their funds to the equities market in search of better returns.

Another analyst said that “given the current lack of alternative investments compared to equities, news-driven and speculative elements could easily drive share prices up,”. Meanwhile, some investors had also adopted a high-risk for high-return attitude, which had buoyed by the market rally seen since the March rout.

One analyst even said investors are feeling good, believing luck is on their side. This gain in confidence has prompted some to try their hands at penny stocks,” he said.

Another analyst quoted in the report said that “I think market participants have earned quite a bit of money from glove and tech stocks. So, without any fresh leads from the market now, they believe the next best option is penny stocks,”.

Investors are also adopting contra plays, as they focus on fast turnarounds. This will likely see the brisk trading seen among low-liner stocks be sustained for a while, according to market observers in the report.

As it is, the FBM ACE and FBM Small Cap indices have both far outperformed the FBM KLCI since March.

The ACE index has jumped 122.79% to 7,128.64 points, while the Small Cap index has gained 64.02% to 12,611.81. In contrast, the KLCI, with its basket of blue chips, have advanced 29.82% to 1,583.5.


PEG Corporate Finance and Research view:


Whatever the reasons given for investors rushing into the penny stocks bandwagon, the traditional wisdom that a fool and his money will soon be parted rings quite loud at the current juncture.

However, most investors and traders typically throw caution to the wind as they are buoyed by speculative counters which are pushed up some likely by syndicates and some on pure speculation of rumours and unverified news.

Not all investors and traders can be faulted however. It is clear that penny stocks by virtue of their cheaper share price offer a much higher upside in a rising market than higher-priced stocks. And lower-priced stocks also tend to be more affordable and thus offer higher volume and liquidity to investors.

And in a bullish market, with all sort of media news and rumours, the higher liquidity will bring about much higher volatility, which is a boon for all traders as volatility tends to mean profit to elite traders who knows how to take advantage of such volatility.

Excessive speculation is not good for any market but normal speculation is as the stock market like any other traded markets rely on supply and demand and the presence of arbitragers to aid the correct price discovery in the market.

However, many investors and traders are sucked into manipulated stocks by syndicates as they lack the tools and knowledge to effectively build an effective and efficient portfolio of penny stocks. In fact, a penny stock portfolio if constructed correctly would easily outperform many institutional funds portfolio returns in the market.

Without the correct tools and knowledge however, most investors and traders are sucked into “syndicate” or manipulated stocks and most often are left holding the baby when the money leaves the stock after a play. This is a problem that present a dilemma to even moderate investors or boutique funds as if they do not participate, they may miss the boat of a rising market.

Being too stubborn and refusing to change one’s strategy in different market conditions is also not the right strategy. For example, even professional fund managers who adopt a value strategy in a growth market is likely to see severe underperformance. But this is another topic for another day.

So, could one still partake in penny stocks play on the market and yet be more comfortable with the risk-reward composition of your portfolio?

Of course one can do so easily. Otherwise there won’t be small-cap professional or boutique funds out in the market. But not all of them are equal our course just like there are good fund managers but there are also many sub-par traders or professionally managed funds in the market.

There are many ways to create a reasonably safe penny stock portfolio using the fundamentals approach (financial data) and also through the tactical approach (using algorithm and technicals). In fact, in our view, the best approach is to create a blend of both by marrying the best in each of the two approaches both strategically and tactically.

In fact, a penny stock portfolio may turned out in the end to have a lower risk-reward profile than a high-priced one as it all depends on the overall alpha and beta of the portfolio.

– The beta (β) of an investment security (i.e. a stock) is a measurement of its volatility of returns relative to the entire market. It is used as a measure of risk and is an integral part of the Capital Asset Pricing Model (CAPM). A company with a higher beta has greater risk and also greater expected returns.

– Alpha measures the amount that the investment has returned in comparison to the market index or other broad benchmark that it is compared against. Because alpha represents the performance of a portfolio relative to a benchmark, it represents the value that a portfolio manager adds or subtracts from a fund’s return.

With the right tools and knowledge, an elite investor and trader can easily construct a reasonably safe portfolio of penny stocks to hold in his portfolio. Let’s just outline a simple way (out of so many ways) of creating a fundamentally sound portfolio of penny stocks.

If one believes in the views of analysts (or at least in the view that a consensus stock – i.e. those with analyst coverage) would have at least some sound fundamental backings, one can start with the consensus call by analysts, who rate recommendation on stocks and put a theoretical fair price value on the stock valuation.

In fact, our research on consensus stocks fair value by analysts show that out of the around 300 stocks on Bursa Malaysia which are covered by financial analysts, around 20% of them or 60 stocks are actually penny stocks (if one classified a penny stock as being priced less than 50 sen).

And out of these, there are around  30 stocks covered by analysts that are priced less than 30 sen in their share price (see table below).


 



But is this enough to create a robust yet rewarding portfolio of penny stocks? We certainly do no want sound fundamental stocks but which are slow-moving and perform poorly especially in a bullish market.

So, how can you do further filtering of your selections to ensure that you are getting the best blend of both fundamental and tactical stocks in your penny stocks portfolio? Stay tuned for Part 2 where we do further analysis of the stocks selected above.

And in Part  3 and Part 4, we move on to the more “exciting” part for aggressive investors and elite traders and how we can select a penny stock portfolio where the “action” and “speculation” are and yet be able to keep the portfolio to a manageable risk.

In fact, depending on the risk and reward ratio, an elite trader should not just anticipate the action but chase the action itself.  

This is the most rewarding part of being an elite trader but you must have your own trading edge and knowledge to do it to manage the risk-reward outcome effectively.

Most traders lose big money as they chase blindly on “aggressive” stocks without having an edge over others or an effective trading system to do it. In other words, instead of buying low and selling high, they frequently buy high and sell low and repeat the cycle again and again.

As for us, we believe our proprietary quantitative research and algorithm is the trading edge to create super or above- normal performance in the market. What would be your own trading edge and how has it work for you?




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Certain information has been redacted and the full content is restricted to PEG Holdings clients, shareholders, fund management entities, and any affiliates or business partners approved by PEG Holdings only. You can register your interest and personal log-in here.

The content in the Research and Market section are only for general market information and should not be construed as an investment advice or constitute a recommendation to buy, hold or sell any instruments or markets. The information represents our personal view only and is for educational and general purposes only.

You should consult with your licensed investment adviser before attempting any real-life trading or investments in the marketplace. All information provided can change without notice and is not guaranteed for accuracy and completeness and is not for use by the general public. Please view the full disclaimer and terms and conditions notice here.

Please note that all algorithms calculated are dynamic and will change as prices, volume and other proprietary factors etc. move in real time.  All information pertaining to any technical or algorithm content are the proprietary assets of our affiliate partner, Bulls and Bears Research.

For more information on the algorithm, please contact our Corporate Finance and Research unit at:


Steven Liew
Head of Strategy
stevenliew@pegroupholding.com

Albert Ting
Head of Corporate Finance
albertting@pegroupholding.com

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