When looking for penny stocks to buy, I like to focus on what I believe are the market’s best opportunities. What I mean by this is I want to buy companies I know and understand, which have a strong competitive advantage, solid balance sheet and room for growth.
Right now, one company I believe ticks all of these boxes is the estate agent group Foxtons (LSE: FOXT).
Drawbacks of buying penny stocks
Before I go on, I should highlight the risks of buying penny stocks. With a market capitalisation of less than £150m, Foxtons is a relatively small business. As such, the company could lack the checks and balances that tend to be in place at larger enterprises.
I am comfortable with this, but other investors may not be. It could expose them to significant risks, which are not present in blue-chip stocks.
Further, Foxtons may have trouble raising money if it runs into financial difficulty due to its smaller size. There is also the potential for corporate governance issues as smaller companies may lack the management oversight that tends to be in place at larger enterprises.
Still, despite these risks and challenges, I am encouraged by the group’s outlook for the next decade.
Foxtons is currently taking advantage of the buoyant housing market. Group revenue for the nine months to the end of September increased 50% compared to 2020 levels and 24% compared to 2019 levels.
Buying and selling houses can be a profitable venture. It is also quite cyclical. To help reduce the cyclical nature of the business, Foxtons has been beefing up its lettings division. Lettings can provide a more predictable revenue stream as the group takes a slice off every monthly rental payment.
To that end, Foxtons recently spent some of its pandemic windfall on acquiring Douglas & Gordon, which bought with it a substantial lettings portfolio. Thanks to this acquisition, lettings revenue increased 28% for the nine months to the end of September. Lettings revenue totalled £58m for the period, including a £7.1m contribution from the acquisition.
Looking for investments to buy and hold, I focus on companies that operate in predictable markets. Property falls into this category. Even though the market is cyclical, people will always be buying and selling houses. There will also always be a need for rental properties.
As such, I think Foxtons has somewhat of a defensive nature. These are the reasons why I would buy the company for my portfolio of penny stocks, to hold until 2030.
I think the group has significant growth potential over the next few years. By reinvesting its pandemic windfall into acquisitions, management should be able to build a recurring revenue stream, which could justify a higher valuation for the stock. This would reduce the cyclical nature of the business and could potentially lead to higher investor returns.
Rupert Hargreaves 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.