What are High Volatility Stocks?
Stocks which are highly volatile and are readily affected by stock market fluctuations can be classified as high volatility securities. Equity shares of small and mid-cap companies are usually classified as volatile stocks and are subject to both systematic and unsystematic risks of the stock market.
High volatile stocks in NSE are popular among institutional investors and individuals willing to assume a high market risk in order to earn high profits through market trends. A characteristic feature of such stocks is its high risk, high return ratio.
How to Identify a Volatile Stock?
A popular measure of volatility is the beta index, which takes into account the effects created by any market fluctuation on a certain stock, and compares the same with changes in the benchmark index. Shares having a beta value of 1 are considered to be a relatively safe investment venture, as the market fluctuation is in tune with changes demonstrated by the biggest companies in a country.
On the other hand, a beta value of less than 1 indicates relatively stable security, while beta higher than 1 indicates extensive fluctuations in response to market changes, and hence, is considered to be a risky investment tool.
Volatile market security is associated with beta values higher than 1, as it is readily affected by minor variations in stock market indicators. This is because any sign of change creates uncertainty regarding the performance of a company in the modified economic conditions, and hence, creates a rush regarding purchase or sale of the stipulated asset in the market.
As a result, the trade volume of such stocks is high, acting as another indicator of its volatile nature.
Advantages of Investing in a high volatility stock
Investing in high volatile stocks in NIFTY 50 comes with several benefits enumerated below –
- High returns
High volatility stocks in 2020 are primarily issued by small and mid-cap companies or start-ups showing tremendous potential for growth and are expected to thrive during favourable economic conditions. Such organisations usually produce goods and services having industry-first features, and hence, are highly demanded in the market.
These highly volatile stocks demonstrating a robust growth potential with adequate cash flow and favourable market conditions can also be termed as value investment securities, as their respective share prices in the future can grow significantly to generate capital gains for investors.
Following a value investment regime can help investors increase their wealth holdings substantially, by assuming market advantage to purchase respective securities at prices lower than their respective book value.
- Lower costs
Shares of small and mid-cap companies trade at relatively lower prices when compared to securities issued by large-cap and blue-chip organisations.
Such lower prices are derived in the stock exchange due to the following reasons –
- Lower demand in the market
High volatility stocks often have lower demand in the market, especially during times of economic and political turmoil. This is because investors are unsure about the performance of a company during such times of stock market downtrend, thereby creating widespread panic.
- Fall in the market value
The market value of a company as reflected by its market capitalisation is significantly low for organisations issuing high volatile stocks in NSE, due to both a lower share price valuation, as well as smaller number of outstanding shares in circulation.
Nonetheless, such parameters do not reflect the intrinsic potential of a company, as depicted by their book value. Purchasing such undervalued best high volatility stocks is a primary strategy of value investing, as the profit-generating capacity of such companies is extensive. Thus, the share prices are expected to rise substantially in the future, helping investors earn significant long term capital gains.
- Suits all investment goals
Individuals having both short and long term investment plans can opt for investment in such securities. As growing companies perform well during times of economic boom through increased cash flow and aggregate demand for goods and services, individuals procuring high volatility stocks can realise profits for a short lock-in period.
Nonetheless, holding high volatile stocks in NSE for an extended period can help investors realise substantial gains, as upon sizable growth of such companies, substantial dividend pay-out regime is undertaken as well.
Also, the stock prices are likely to demonstrate significant linear growth (barring complications due to unsystematic risks) in the long term, ensuring substantial long term capital gains on locked-in investment.
Limitations of Highly Volatile Stocks
Despite enticing benefits, high volatility stocks come with certain restrictions, such as –
- High risk
High volatile stocks in NIFTY 50 are significantly affected by any market fluctuation. Any negative outlook in stock market trends and socio-political events cause significant fluctuations in the stock prices. Such companies rely heavily on equity sources, which form the base funds required to meet all operational expenses. During times of economic turmoil followed by panic among investors in a country, lower availability of funds often reflects poorly on the annual revenue and turnover.
Hence, such fluctuations in the stock prices can result in losses on part of investors having a short term investment goal, as market downtrends can last for as long as a year.
- Value trap
All companies ranked in the high volatility stocks list have high systematic risks associated with an overall investment, as the credentials of the company are not accurately displayed through its market value. Individuals often attribute undervalued shares to unsystematic risks, not taking into account the financial foundation and management of the company. In case of investment in such companies, any downturn can lead to potential bankruptcy, and operational shutdown, causing investors to lose out on the principal equity investment wholly or partially.
Identifying a value trap investment can be challenging, as such companies perform well in times of economic boom or during a potential asset bubble. However, the true potential of an emerging business is indicated by intrinsic value indicators, such as price to earnings ratio, EBITDA, discounted cash flow models, etc.
- Sectoral downtrends
High volatility stocks are heavily influenced by sectoral performance, which, in turn, is dependent on business cycle fluctuations. Even companies having an unstable foundation can show excelled performance during such times, which might lead investors to believe that investing in such companies can be a profitable venture. However, without evaluating the intrinsic technical analysis variables, the true potential of growth cannot be concluded, and hence, might lead to substantial losses if the performance of the company is based on only booming market conditions.
Such a situation was observed during the dot-com bubble in America in the 2000s, when investors had an optimistic opinion regarding the growth and expansion of companies operating in the technology sector. With significant investments being pooled into this sector, companies readily spent an extensive portion of their budget on advertising and marketing, thereby shifting focus from the production and R&D units.
As a result, when the asset bubble collapsed, numerous companies declared bankruptcy, leading to tremendous losses for both American residents and foreign investors having a significant stake in the asset portfolio of tech-based US companies.
However, companies focusing on product quality during such times thrived and is one of the major business organisations today. eBay and Amazon can be cited as an example under companies surviving the dot-com bubble.
- No dividend pay-outs
High volatile stocks list primarily deals with companies having a market capitalisation value of less than Rs. 20,000 crore (small and mid-cap companies). Revenue generated by such companies is usually reinvested in the business to fund all expansion projects, to fuel its growth rate. As a result, investors do not enjoy periodic dividend benefits on their respective equity shares.
Thus, highly volatile stocks are not ideal for individuals looking for investment options generating steady cash flow at regular intervals.
A high volatility stock is equity-oriented, and hence, taxed accordingly. If the holding period of such shares is less than one year, any capital gains realised is taxed at 15% of the total earnings. Long term capital gains tax is levied if the stock was in possession of an investor for more than one year, and attracts a charge of 10% of the total earnings recorded.
Who Should Invest in Highly Volatile Stocks?
Individuals having a high-risk aptitude and adequate knowledge regarding the intrinsic value indicators can invest in high volatile stocks in NSE for extensive return generation through capital gains. Investors should know how to read any stock market fluctuation as well, as it affects the stock prices significantly. Any decision regarding purchase or sale of securities can be undertaken based on predicted market operations.
However, having a long term investment outlook is ideal for investing in such high volatility stocks, as a sizable change (increase) in the stock prices can be noticed, irrespective of short term downtrends. Also, tax on long term capital gains is relatively lower than that levied on short term capital gains.
Thus, stocks issued by emerging companies having a stable foundation are a good investment avenue for individuals who are willing to assume all short term risks and keeping their portfolio locked in for an extended period. While returns generated can be manifold, proper analysis of the fundamentals of such a business is crucial to mitigate the systematic risks involved.