When it comes to penny stocks, I like to focus on companies that have a reliable and stable market, as well as an established reputation.
Indeed, investing in small firms can be incredibly risky. I think concentrating on already-established businesses is an easy way to reduce risk.
It’s also easier to see how an established business has fared in different market environments. I can’t do that with a newer enterprise.
Penny stocks on my watchlist
Finsbury Food (LSE: FIF) is a good example. The baker, which produces cakes, bread and bakery snacks, has been a public business since 1995.
Unfortunately, growth has stagnated during the past five years, but that’s set to change in the next two, according to analysts. City analysts have pencilled in a net income of £11.2m for 2021, the highest level in over six years.
I’m always wary of City estimates, but it looks as if the firm is well on the way to hitting this projection. In a trading update published in May, the company announced that profit before tax for its 2021 financial year would be “no less than £15m.” That’s above projections.
I think the company has the potential to build on this growth in the years ahead. That’s why I’d buy the firm for my portfolio of penny stocks as a growth investment.
That said, it’s clear Finsbury Food has struggled to grow in the past. Therefore, there’s a chance 2021’s performance could be an exceptional year. Rising costs may eat away at profit margins and cause growth to slow. That’s something I’ll be keeping an eye on.
As the economy reopens, the demand for goods and services is increasing. Rising demand is particularly acute in the logistics sector. Prices are rising as companies struggle to meet customer demand.
To play this theme, I’d buy Xpediator (LSE: XPD) for my portfolio of penny stocks. This company provides freight management services. And demand for these services is increasing.
In fact, it’s rising so fast that the company has already increased its projections for the year. Management believes the enterprise is well-placed to deliver full-year adjusted pre-tax profit “in excess” of £8.5m.
By comparison, Xpediator’s cumulative net profit for the last three years was £7.2m. I think these figures illustrate just how much of an impact the current situation is having on the company’s bottom line. That is why I’d buy Xpediator for my portfolio of penny stocks today.
However, it does have some significant weaknesses. Profit margins are incredibly thin. The average for the past six years is just 3%. That doesn’t leave much room for error. If costs rise substantially, the company’s profit margin could disappear. Moreover, profits could also decline if freight transactions return to pre-Covid levels.