Lottery Stocks: Why Investors Love Long Shots

Why investors overpay for cheap, speculative stocks with a small chance of huge gains, and what research finds about their returns.

Many investors are drawn to cheap, speculative stocks: tiny companies, penny stocks or newly listed firms that might multiply in value. Like lottery tickets, they offer a small chance of a huge payoff. Research suggests investors overpay for this chance.

Probability weighting

Prospect theory, developed by Kahneman and Tversky, shows that people overweight small probabilities. A 1 percent chance of a big win feels more likely than it is. This explains why people buy lottery tickets and insurance at the same time.

The evidence

Economist Alok Kumar found in 2009 that individual investors, especially those with lower incomes, preferred stocks with lottery-like features: low prices, high volatility and a chance of extreme gains.
Studies find that stocks with the highest chances of extreme positive returns tend to have lower average returns later, suggesting investors overpay for the dream.

Why they attract investors

Low share price: a stock at 5 rupees feels cheap, though price per share says nothing about value.
Stories of stocks that went up a hundredfold.
Excitement and entertainment.
Hope of changing one’s financial situation quickly.

Risks

Manipulation: small, thinly traded stocks are easier to manipulate through pump-and-dump schemes, often promoted on messaging apps.
Poor disclosure and weak governance.
Illiquidity: it can be hard to sell.

SEBI has acted against pump-and-dump schemes promoted through social media and messaging groups.

A sensible approach

If you enjoy speculating, some advisers suggest limiting it to a small “fun money” portion of your portfolio that you can afford to lose, keeping your core savings diversified.

The five-rupee stock

An investor buys 10,000 shares of a five-rupee company after a message group claims it will "multibag". The price briefly doubles as promoters sell, then collapses to one rupee. The cheap price had made it feel low-risk, but it was the opposite.

Thinking a low share price means a stock is cheap

Price per share doesn't show value. A 5 rupee stock can be expensive, and a 5,000 rupee stock can be cheap relative to earnings.

Key takeaways

Lottery stocks offer a small chance of huge gains.
People overweight small probabilities, so they overpay for long shots.
Research finds such stocks tend to have lower average returns.
Small, thinly traded stocks are prone to pump-and-dump manipulation.