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How I’d buy penny stocks, and 1 with HUGE potential!

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Sometimes I think penny stocks get a bad reputation for being high-risk. It might be true in some cases, but the price of a share shouldn’t detract from what could be a very good business.

I’ve written about a penny stock in the FTSE 100 before, and about some that I think show potential for strong growth.

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Buying penny stocks is just like investing in any other shares. So, here’s how I buy them, and one that I think could explode from here.

Buying penny stocks

When buying any stock, I always use my Stocks and Shares ISA. There’s a great article on The Motley Fool describing what this is. In summary, it’s a tax-efficient wrapper that shelters all investment gains from tax. This includes capital gains and income. That’s it really. Buying shares in an ISA is just like any other trading account, just with the tax benefits.

Then I use an online execution-only broker account. There’s another great article on The Motley Fool that compares these platforms here. I use Interactive Investor, which is described on the link I shared. I can buy penny shares on this platform, but there are others worth considering.

A penny stock with huge potential

This brings me to a penny stock I’ve been researching lately. It’s Velocys (LSE: VLS), and is currently valued at almost £120m, but with a share price of 11p at time of writing. The stock is up a huge 120% over one year, but I think it might just be getting started.

The company’s technology enables sustainable fuels to be made from waste materials for aviation and heavy goods transport. The fuels are high-quality, which means no changes are required to existing engines. It’s a great play on ESG (Environmental, Social and Governance) investing because the technology helps to achieve net zero emissions and improve air quality.

Just last week, potential game-changing agreements were announced with AIG and Southwest Airlines. Velocys will produce its sustainable aviation fuel for these airlines at the Bayou Fuels plant it’s developing in the US. The agreements combined cover 292m gallons of sustainable aviation fuel, extending over a minimum of 10 years beginning in 2026.

According to Velocys, the agreements have the potential to generate multi-billion revenues over the life of the contracts. An estimated 8.7m tonnes of carbon dioxide emissions will also be avoided.

Risks ahead for this penny stock

There’s clearly huge potential in these two agreements alone. But the Bayou Fuels plant is still only in development, and is a first of its kind for Velocys. There can be no guarantee of success. But management remains confident that the plant will be ready for delivery of the fuel by 2026.

The agreement with AIG is also non-binding, so there’s further risk that this doesn’t go ahead exactly as planned.

Velocys is also loss-making and hasn’t been able to generate consistent revenue. Before I buy the shares, I have to be confident that the recent agreements will be a turning point for the company’s financial performance.

Final thoughts

On balance, I think it’s a touch early for me to buy this penny stock. I’m going to watch how the Bayou Fuels plant develops, but I’m encouraged by the recent agreements.

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Dan Appleby 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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