Penny stocks are some of the worst-performing investments during a market downturn. These are usually first in line to be sold off as investors panic to try and minimise losses. And it isn’t exactly surprising.
After all, these tiny businesses don’t typically have much access to capital and are highly sensitive to economic conditions. This is made perfectly clear when looking at the FTSE AIM All-Share index, down more than 40% since inflation crept into the limelight.
Since then, economic conditions in the UK have drastically improved. And interest rates are even starting to come down.
However, the damage inflicted on many of these businesses still needs some time to be repaired. And this handicap could cause plenty of penny stocks to continue falling even though the worst might be over. But that could also spell opportunity for one business if it tumbles to the right price.
A potential industry leader?
ITM Power‘s (LSE:ITM) a business I’ve been keeping tabs on for many years. And since 2020, I’ve been fairly critical, especially in regards to its valuation. Looking back, I see that my concerns were spot-on.
The group has promising electrolyser technology that enables hydrogen extraction from water without creating carbon emissions. That makes it far more sustainable than traditional hydrogen sources like crude oil.
The hype surrounding hydrogen as an alternative fuel source sent shares skyrocketing in 2021. Investors were so focused on the long-term potential that they grew blind to the immense challenges of transitioning from a research-based to a production-based company.
As I feared, customer orders started getting continuously delayed as management tackled the challenges of the transition. And with investor’s unrealistic expectations not being met, the share price crashed by more than 90% within two years.
But the company’s far from doomed. Its technology works. And while the hydrogen market‘s still in its infancy, there’s active demand for gas in the aerospace, healthcare, and energy sectors.
Management’s been simplifying its production line, helping to clear the backlog of orders. Subsequently, revenue started moving in the right direction. And while the firm’s still a long way off from being profitable, losses from operations in its 2024 fiscal year ending in April fell by more than 60%!
In other words, ITM Power’s starting to look more and more like a viable business.
Finding the right price
Despite the collapse of its valuation, ITM Power shares aren’t in penny stock territory yet (a price in pence and a market cap below £100m). The price technically is but the market cap is still well above that figure. Yet that could change. Even at current prices, the shares are still trading at a premium with a price-to-sales ratio of around 18.7.
For reference, the average across the FTSE is usually around 3. That means high levels of volatility are to be expected, especially if the stock market decides to take another tumble down the line. Should this business return to penny stock territory while maintaining operational progress, then I will be finally ready to invest in this enterprise, albeit with a small initial position.
This post was originally published on Motley Fool
