Penny stocks are known for their volatility, and more often than not, they do end up being a bit of a damp squib, in my view.
However, there are some that do flourish, and some former small caps do now reside on the FTSE 100, the UK’s premier index.
What I look for
The biggest trap investors can fall into is thinking the best penny shares to buy are those that are the cheapest. I’ve learnt that there’s a difference between price and value.
So while I look at value, I can only ascertain this by doing a thorough review of the business and its fundamentals. Not all penny shares have lots of information readily available. So, if a stock has minimal information, that’s usually a red flag.
Next, I want to understand a firm’s financial health, as well as what it’s offering as a business. Is it future proof? Furthermore, what’s performance been like historically?
These aspects help me make a decision as to whether or not I’d even consider buying some shares.
Former penny stocks that made it big
Two notable former penny stocks that made are Ashtead and JD Sports Fashion. Both businesses started out small but have flourished. It’s fair to say they’re now established FTSE 100 incumbents. However, that doesn’t mean they don’t operate without risks or that there weren’t bumps in the road.
For example, JD Sports Fashion operates in the sportswear and leisure market. This is a market that exploded in recent years, and the firm has benefitted. Nevertheless, recent volatility has hurt consumer spending, and in turn, the company’s performance and share price.
For Ashtead, one of the largest construction rental businesses, volatility has also hurt its performance. Construction projects have been put on the back burner due to high inflation and fears of a recession.
One penny stock I don’t think will soar
I reckon it’s hard to pick which stocks will make it big, but easier to pick those that maybe won’t.
One pick I don’t think is worth considering for me is Petrofac (LSE: PFC).
Over a 12-month period, Petrofac shares have shipped 81% from 74p at this time last year, to current levels of 14p. Over a five-year period, they’re down a whopping 96% from 400p to current levels.
The oil and gas facilities provider has had to contend with falling revenues, increased borrowing, which has put strain on its balance sheet, as well as other scandals. A cocktail for disaster, if you ask me.
Earlier this year, a $1.4bn contract win relating to renewable energy work was a bit of a bolt out of the blue. However, it hasn’t done much for investor sentiment. Instead, question marks around the firm’s liquidity have continued to bog ity down. Plus, bribery scandals from previous years are dark clouds which the business can’t seem to shake off.
In the past, prominent brokers such as JP Morgan have raised concerns about Petrofac’s financial health.
Taking everything into account, I wouldn’t touch Petrofac shares with a bargepole. I’ll still keep an eye on developments, and who knows, things might turn around!
This post was originally published on Motley Fool
