Penny Stock Master Series: Surviving the Perfect Storm

Welcome to the third and the concluding part of our penny stock master series.

In case you've missed the first two, you can access them here and here.

Just to recap, our penny stock blueprint has really painted itself in glory by multiplying our corpus by a huge 12x in the first seven years.

Yes, that's correct.

In a stock market that was up just 70% in 7 years, a penny stock portfolio built with the rules from my blueprint, was up a massive 12x.

It has had only one down year so far, giving us several multi-bagger penny stocks.

But now we are in the final three years of the decade.

So the key question is, did the portfolio has continue to pile on the returns? Are more gains in store for the portfolio?

Unfortunately, the answer to the question is no.

As I highlighted earlier, the portfolio is yet to encounter a bear market and so, it's yet to face its most difficult test.

Well, we didn't have to wait too long for the portfolio's trial by fire.

The next couple of years turned out to be the most brutal for mid and small caps, the segments where most of our penny stocks come from.

First, the small cap index fell 23% in 2018. Then fell by another 34% over the next 15 months.

This resulted in a huge meltdown of 50% from top to bottom. Ouch!

It was not uncommon to see the strong gains of the bull market of 2014 to 2017 being completely wiped out by this crash. It was stock market carnage at its worst.

Given the turn of events, did our penny stock portfolio also go down by 50% or an even bigger decline?

Well, here's where one of the most important rules in my penny stock blueprint really took centre stage.

Towards the end of 2017, our market valuation indicator started flashing red. It pointed to the huge danger that lay ahead.

Not only did the broader market valuation enter the overheated zone, the number of penny stocks that passed our buy filters also came down to a multi-year low.

This was an indication to us that for the first time in seven years, it was time to move the allocation between penny stocks and fixed deposits from 75:25 to the other way round.

It was time to have only 25% invested in penny stocks and keep the remaining 75% in fixed deposits or bonds.

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We did exactly what the blueprint asked us to do.

And what a decision it turned out to be.

We managed to escape the carnage of 2018. We suffered only a 7% fall in the overall portfolio. This compared to the more than 20% correction witnessed in the BSE Small Cap index.

2019 was however the worst year in the history of the portfolio as we went back to 75% in penny stocks, a move that now seems ill-timed in hindsight.

As a consequence, the portfolio fell by 26% and the overall returns shrunk from being 12x towards the end of 2017 to a little under 9x by the end of 2019.

Some of the big losers in this two year period were the following penny stocks.

• Balasore Alloys, down 64% in 12 months in 2018.
• JHS Svendgaard, down 54% in 12 months in 2018.
• Sankhya Infotech, down 95% in 12 months in 2019.
• TGB Banquets, down 79% in 12 months in 2019.

Well, as these losses show, investing in penny stocks is not a bed of roses.

However, once you have a proper risk management in place and have a proven game plan, these losses are part and parcel of the game in my view.

2020 was the year when we broke the streak of losses and the portfolio was once again up 15% for the entire year.

The reason we were up just 15% in a year where the benchmark index was up more than 30% was because of the allocation.

For the second year in a row, our allocation indicator gave a wrong signal and we ended up being only 25% in penny stocks when we should have been 75%.

Does this call for the allocation signal to be abandoned and be replaced by a new indicator?

Certainly not.

No valuation indicator will work 100% of the time.

As long as it works more often than it doesn't, we should stick with it. Our valuation indicator worked 70% of the time i.e. it gave us the right allocation signal 7 times out of 10.

It gave the right call to be 75% in stocks in years when the stock market went up and switch to 25% when the stock market went down.

And it gave wrong call in only 3 out of the 10 years. I believe that any fund manager would give an arm and a leg for a valuation indicator that's 70% accurate.

You will get more details about this valuation indicator in my free web summit scheduled for tomorrow 5.00 PM.

Click here if you haven't registered for it already.

Let's come back to the performance during the last 3 year period of the decade.

The portfolio ended up lower than what it started the period with. If you will recollect, the portfolio was up more than 12x at the end of the 7-year period.

However, because of the losses it incurred in 2018 and 2019, it closed the period 20% lower and 12x came down to 10x.

But the silver lining in this is that we did eventually end up multiplying the corpus by 10x in 10 years.

We preserved most of the capital in one of the most difficult periods for penny stocks in recent years.

The Final Verdict

It's time for the final verdict now.

Is our blueprint for penny stock effective? Can it be relied upon to build a market beating portfolio of penny stocks?

If the results of our test is any indication, I believe the answer should be an overwhelming yes.

The true test of any strategy is how it performs over a long year period of minimum 3-5 years and also across different kinds of markets. I believe that my blueprint has passed both these exams with flying colours.

Not only has it proven itself over a period as long as 10 years but has managed to give good results across all kinds of markets.

Be it a sideways market, a bull market or a bear market, the strategy has performed very well.

I am sure one key question is bothering you. If investing in penny stocks is so easy, why aren't more people following this blueprint?

Why do they behave like speculators and come with virtually no game plan of investing in penny stocks?

Well, as Peter Lynch says, investing is less about the brain and more about the guts. I believe that rules for investing are extremely simple.

But having the character to stick with them is extremely difficult.

All strategies will have their up years and down years. Therefore, you need to ensure you need to stick to your strategy during a down year so that you can capitalise on it on the way up.

Most investors are not able to complete this journey. They get restless after a year or two of bad performance and jump ship at precisely the wrong time.

This is certainly not a good approach to have over the long term.

Thus, it's very important to stick to a strategy once you've verified that it's a sound one. You should not get disheartened with a year or two of bad performance.

Well, if you join me on this journey of penny stock investing, I will keep you on track and see to it that we are following the process at all times.

And once we do that, the results will take care of themselves, just like they did during our 10-year back testing.

So do join me as I reveal my penny stock blueprint that aims to pick multibaggers.

It is one which coincides with the perfect buying conditions in the market.

Click here to read more.

Good Investing,


Rahul Shah
Editor, Profit Hunter
Equitymaster Agora Research Private Limited (Research Analyst)

PS: Join me tomorrow at 5 pm sharp for my 10X Summit. I'll will show you how to find the most profitable stocks in the market today. Book your free seat here.