The Cross-section of Expected Returns on Penny Stocks: Are Low-hanging Fruits Not-so Sweet?

TL;DR

This study investigates the determinants of expected returns on penny stocks in India, highlighting how factors like market capitalization, P/E, P/B ratios, and stock prices influence returns, with minimal impact from trading volume or shareholding patterns.

Contribution

It provides empirical evidence on penny stock return dynamics in an emerging market, emphasizing the significance of firm-specific valuation metrics and market cap in return variations.

Findings

Lower market-cap penny stocks yield higher returns.

Lower P/E, P/B, and priced penny stocks have significantly higher returns.

Trading volume, beta, and shareholding patterns show insignificant effects.

Abstract

In this paper, we study the determinants of expected returns on the listed penny stocks from two perspectives. Traditionally financial economics literature has been devoted to study the macro and micro determinants of expected returns on stocks (Subrahmanyam, 2010). Very few research has been carried out on penny stocks (Liu, Rhee, & Zhang, 2011; Nofsinger & Verma, 2014). Our study is an effort to contribute more empirical evidence on penny stocks in the emerging market context. We see the return dynamics of penny stocks from corporate governance perspective. Issues such as shareholding patters are considered to be of much significance when it comes to understand the price movements. Using cross-sectional data on 167 penny stocks listed in the National Stock Exchange of India, we show that (i) Returns of portfolio of lower market-cap penny stocks are significantly different(higher) than that of higher market-cap penny stocks. (ii)Returns of portfolio lower P/E stocks are significantly different (higher) than that of higher P/E stocks. Similarly, returns of portfolio of lower P/B stocks are significantly different (higher) than that of higher P/B stocks, and returns of portfolio of lower priced penny stocks are significantly different(higher) than that of higher priced penny stocks. (iii) Trading volume differences due to alphabetism are insignificant. (iv)Differences in returns of portfolios based on beta and shareholding patterns are insignificant.