My Penny Stocks Outlook for 2023

Most likely, you'd be reading this piece on the second day of a brand-new year. So, here's wishing you all a Happy, Healthy and a Prosperous New Year.

I run a penny stock recommendation service at Equitymaster and have been at it for more than four years now.

In fact, I have put together a decent track record of recommending 30 winners in a row and helping my subscribers almost double their money in the service since inception. I believe this is an impressive track record in a highly volatile space like penny stocks.

However, if you think this track record was possible because of raw intelligence or unusual business insights or perhaps even inside information, well, let me tell you that nothing could be further from the truth.

This track record is a result of following a well-defined process and having the emotional discipline to stick to it come what may.

Yes, that's correct. All you need to first survive and then thrive in the highly dangerous world of penny stocks is a sound process followed by some hard-nosed discipline.

You see, an average investor thinks of penny stocks as speculative bets. They perceive it as an all or nothing gamble where one should earn multibagger returns and if that involves the risk of losing all your capital invested in them, so be it.

There's nothing wrong in thinking of penny stocks like this in my view. As long as you know that you are speculating and are allocating only a small fraction of your net worth to this activity, speculation will do no significant long-term damage to your wealth.

In fact, I see it as a necessary evil so that you don't end up speculating in the portfolio that you've set aside for serious long-term wealth creation. This should be run using sound investment principles and no speculative tendencies should be allowed to corrode this framework of yours.

Anyways, coming back to penny stocks, the reason I have had some success with them is because I don't see them as speculative bets.

I'm of the view that one can create serious long-term wealth from penny stocks, provided one views them as investments and follows sound investment techniques and principles.

My track record is proof that the rules I have set aside for penny stock investing do have merit in them and can work in the real world as well.

So, what exactly are these rules and how should one go about applying them to the world of penny stocks.

Well, the most important rule is that there are times when investing in penny stocks can bring you huge rewards and then there are times when they can cause some severe damage to your wealth. Therefore, knowing which one is which is the key to maximising your wealth in penny stocks.

You see, people get interested in penny stocks only at the top of the bull market or when market is nearing its highs. This is absolutely the worst time to invest in penny stocks because when the market crashes, penny stocks are often the worst hit.

So, here's an important advice. Minimise your exposure to penny stocks when the Sensex PE multiple is 24x-25x or higher. You see, the Sensex has traded at a PE multiple of around 20x-21x on average over the past few decades.

And whenever it has crossed a PE multiple of 25x, stock market returns over the next 1-2 years have been way below par on an average.

The years 2018 and 2019 did witness something of this sort. Out of the 200 and 300 stocks that cleared my penny stock filters in 2018 and 2019 respectively, a huge majority of them closed the year in the negative.

To be more specific, only about 8% and 13% of the penny stocks gave positive returns in these two years. This means that a huge 90% of the stocks closed both these years in the negative.

And what was the Sensex PE ratio during both these years? Well, it was in the region of 24x-25x.

Of course, there have been years when the Sensex PE has been 25x or higher and penny stocks have still gone on to give good returns. However, in the interest of safety first, I will still not recommend a high exposure to penny stocks when the Sensex PE goes north of 25x.

On the other hand, a high exposure to penny stocks is recommended when the Sensex PE goes below 20x. This is when the Sensex becomes attractive from a valuation standpoint and has a high possibility of doing well over the next couple of years and so do penny stocks.

Going back, the years 2013 to 2017 were the years where the Sensex PE did not cross 20x-21x at the start of the year. And guess what, barring 2013, a minimum 50% of the penny stocks from a total of 200 to 250 stocks ended up giving positive returns in those years. In fact, the years 2014 and 2017 saw as many as 80% and 90% of the penny stocks give positive returns.

Thus, both the evidence and the logic seems pretty clear. Minimise your exposure to penny stocks i.e. have only 25% or 30% of your penny stocks fund invested when the Sensex PE is more than 25x.

Also, maximise your penny stock exposure i.e. have close to 75% of your penny stocks fund in penny stocks when the PE falls below 20x-21x. Between 21x and 25x, you can be 50%-60% invested in them.

Ok, so that was about the allocation to penny stocks. However, what about which penny stocks to buy and how long to hold on to them?

Well, this is also quite simple. As you are investing in penny stocks, and not speculating, you should choose fundamentally strong penny stocks and you should buy them at least 30% discount to their intrinsic values.

For this, you need to choose from among a few qualitative factors like the company's debt to equity ratio, its earnings history, its return ratios, and you also need to choose from among its valuation factors like PE ratio or price to book value or even EV/EBITDA.

You can pick two qualitative factors and one valuation factor and put together a portfolio of 15-20 stocks. You hold these stocks for 1-2 years and then keep repeating the process.

I can almost assure you that you won't get poor returns from your penny stock investments if you follow this strategy.

Whether you get outstanding results will depend on the effort and the intellect you bring to the table and also to the opportunities you get to maximise exposure to penny stocks.

Now, coming to the outlook for 2023, the Sensex currently trades at a PE of 23.7x as I write this.

This makes it not very expensive but not very cheap either. Thus, a good idea would be to take say 50% exposure right now to buy almost debt free penny stocks with stable earnings profile, available at single digit PE multiple or at a price less than the book value per share of the company.

In case you need more help to identify such stocks, you can watch my penny stock video where I have shared more details.

It's all about keeping things simple and sticking to the discipline of adjusting your penny stock exposure based on the broader market valuations. Trust me, this is more than enough to earn good long term returns from penny stocks.

So, here's to profitable penny stocks investing in 2023.

Warm regards,


Rahul Shah
Editor and Research Analyst, Profit Hunter