Penny shares are a volatile section of the stock market. Most of these businesses are tiny for a good reason but, occasionally, a diamond appears in the rough. And it seems Premier African Minerals (LSE:PREM) has recently caught investors’ attention. In fact, the penny stock skyrocketed by over 70% last week.
But is this just short-term excitement from traders, or should I really consider this business for my long-term portfolio? Let’s take a closer look.
Investigating the penny stock
Premier African Minerals is an early-stage exploration company. The group did have active tungsten mines a few years ago. But due to complications with Zimbabwe’s National Indigenisation and Economic Empowerment Fund (NIEEF), they’re no longer active.
Since then, it’s been on the prowl for a new development site, and it may have just found it. Management recently released a drilling update for its Zulu project. After performing early-stage tests, the company has confirmed the presence of lithium starting from a relatively shallow depth of 68 meters and with an average grade between 1.05% and 2.02%.
While the ore grade is pretty standard, the drilling location was selected based on a geological model developed by Shango Solutions. The discovery of lithium indicates the model is accurate. And since it also predicted further deposits northwest of the testing site, the mineral resource estimate could be set to increase considerably.
If that wasn’t enough, management has also signed a non-binding ‘Heads of Terms’ agreement with a lithium manufacturer to fund its Zulu project. With money potentially secured, the presence of lithium confirmed, and a possibly larger than expected deposit, it’s hardly surprising to see why the penny stock exploded on the news.
Taking a step back
As exciting as this progress is, investors may be getting ahead of themselves. As I’ve already said, this business doesn’t have a revenue stream. And with limited cash reserves, it needs to find external capital.
But is that fine because of the signed funding agreement? Well, no. The deal is still in its infancy and is entirely subject to further negotiation, as well as plenty of due diligence. Nothing may come of it. And in that case, the penny stock will have to find another investor.
But even if funding is secured, there still remains years of testing and site development ahead before any commercial production can begin. That’s plenty of time for something to go wrong. And it’s one of the highest risk factors early-stage mining companies suffer from.
In other words, the recent boost in the penny stock is entirely driven by expectations rather than fundamentals. In my experience, that’s a dangerous path to take as an investor. After all, if the slightest sign of trouble emerges that could compromise aggressive investor forecasts, I wouldn’t be surprised to watch the penny stock collapse.
Needless to say, I’m not keen on adding this business to my portfolio today. But given time, the uncertainty about its future could dissipate and reveal a thriving investment opportunity. That’s why I’m keeping it on my watchlist.
Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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