Here’s my guide on investing in penny stocks and 1 pick I like!

Jabran Khan offers his guide on investing in penny stocks and identifies one pick that he believes could be an excellent addition to his portfolio.

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I am always on the lookout for new stocks to bolster my portfolio and increase my returns. I do this primarily by reviewing established businesses that are on the main FTSE index. In addition to this, I also look for penny stocks that could offer me excellent returns in the long term due to their potential for growth.

It’s important to understand what defines a penny stock as well as the positives and negatives of investing in such stocks.

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Penny stocks defined

Penny stocks, sometimes referred to as penny shares, are stocks that trade with a share price below £1. These firms also have a market capitalisation below £100m. They are often small, low-valued businesses. Due to this, they offer a higher risk. They can also offer a higher potential reward.

Penny stock investments are considered more speculative compared to buying stock in larger, more established firms. This is because they are geared for growth. Often, the penny stocks I am reviewing may not have generated any income or even developed a viable product or service to bring to market. Here in the UK, penny stocks are listed on the FTSE Alternative Investment Market (AIM) index.

Risky investments

There is the potential to find the next big thing among penny stocks. On the other side of the coin, I must note the very real risks that I face as an investor too. Here are some of the risks I often consider and evaluate when investing in penny stocks for my portfolio:

  • Lack of information. One of my key strategies when investing is doing lots of research and due diligence. I learnt this from following investing role models such as Warren Buffett. For smaller penny stocks, information can be more difficult to find. Some of the information I do find is often from sources I would not class as credible. This has often led me to avoiding certain stocks as I do not feel comfortable investing in a stock I don’t know enough about.
  • Lack of history. Most penny stocks are often newly formed. I personally define newly formed as only a few years old. These firms often have little or no track record to go by in terms of performance, sales, and news. I understand that past performance is not a guarantee of the future. Nevertheless I use it as a gauge when looking at potential stocks.
  • Lack of liquidity. I often find that many penny stocks don’t have much by way of liquidity. This can be an issue for two reasons. Firstly, low liquidity can mean there is little by way of cash for the business to invest in product launches, research and development, as well as other activities that will help it make a profit. Another issue is that low liquidity offers opportunities for stock price manipulation. One way this happens is when someone buys a large amount of stock, hypes it up and then sells it after other investors find it attractive.

One pick I like

With my understanding of penny stocks and the risks involved, I have identified a penny stock I’m looking at buying from the FTSE AIM.

BATM Advanced Communications (LSE:BVC) is a tech firm operating via two core divisions. These are bio-medical and Networking & Cyber Security. Headquartered in Israel, BATM has a global footprint with offices and customers across Europe, North America, and Asia.

BATM’s biomedical division recently joined many other pharma firms in the Covid-19-related product race. It has made good progress too with a portfolio of diagnostic tests and multi-pathogen tests. This has made it a more attractive penny stock for me as it has identified an opportunity to maximise its performance in an emerging market.

BATM’s cyber security arm seems to be its bread and butter, however. It looks to provide services to organisations and governments across the world. It describes it’s target customers as “Tier 1” organisations. For example, it recently announced contracts with unnamed governments to bolster their cyber security. A penny stock which governments worldwide are trusting for their cyber security needs is one worth paying attention to in my opinion.

As I write, shares in BATM are trading for 91p per share. The share price has surpassed pre-pandemic levels by more than 100%, which is encouraging. Shares were trading for 43p per share prior to the pandemic. 

BATM announced positive half-year results in August for the six months ended 30 June 2021. Despite revenue being less than in the same period last year, gross profit was up and the biomedical division was showing excellent growth. BATM said its full-year expectations had increased as a result.

BATM’s past performance has been impressive too. As I said earlier, past performance is not a guarantee of the future. It is a good gauge for me personally, however. Revenue, operating income, and net income have increased year-on-year for the past four years. It also has good liquidity which is a major positive for me. Gross profit has increased for the past two years. In addition to this, its balance sheet has been propped up by healthy cash flow increasing year-on-year for the past four years too.

I believe BATM’s biggest risk is its place in the market and the competition it faces. In its marketplace, BATM can be beaten by larger businesses with more established track records. Many pharma firms have launched Covid-19-related products and many larger cyber security firms are all vying for new business too. This competition could hurt BATM’s financials and investment viability as organisations may opt for its competitors.

Overall, I like BATM as a penny stock. It has solid financials and a good performance history. One other positive I must note is that insiders own shares in BATM. For me, this is a sign of confidence in a business by its insiders steering the ship. Interests become aligned as these insiders will want the business to grow and succeed and they will want to maximise their own returns as investors too. 

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Jabran Khan 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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