Some of my biggest investing wins have come from smaller companies. That’s why I like to keep a lookout for penny stocks that I think are being undervalued by the market.
I’ve been hunting for potential bargains and have found five stocks I’m interested in adding to my portfolio in 2022.
I reckon all of these unloved shares look good value and could deliver big gains over time. But there are no guarantees. Sometimes there’s a good reason why a share is cheap. Problems may be lurking in the background. The business may be losing key customers.
The share prices of smaller companies also tend to be more volatile than larger stocks. Losses (and gains) can be very sudden. For these reasons, I wouldn’t ever invest in penny shares with money I couldn’t afford to lose.
I reckon this share could double
My first pick is a business I’ve been following for some years. I reckon now could be the time to buy. Gulf Marine Services (LSE: GMS) owns a fleet of offshore drilling rigs hired out to customers in the Middle East and elsewhere.
Gulf Marine’s fleet is very modern, but this led to a problem. The company had funded its fleet expansion with debt. By 2016, net debt had topped $400m, but the oil market crash in 2015 had caused demand for hire rigs to slump.
However, the business is under new management, reporting regular contract wins and improved fleet utilisation. Importantly, debt has started to fall.
Gulf Marine shares currently trade on just 3.5 times 2022 forecast earnings. This reflects the company’s high debt load. But if debt continues to fall, then I think the shares should re-rate to a more normal valuation.
This is still a risky situation. Debt is still very high and the current boost from high oil prices may not last. But if trading remains good, I think Gulf Marine’s share price could rise strongly from current levels.
Can this quality business keep growing?
My next pick is quite different. Currency specialist Record (LSE: REC) provides services to clients who need to manage their foreign exchange exposure. It’s a highly profitable business, with an operating margin of about 30%.
The problem is that growth has been pretty weak in recent years. Between 2017 and 2020, profits were broadly flat.
Newish chief executive Leslie Hill has brought in some fresh ideas and seems to have restarted the group’s growth. Revenue rose by 38% to £16.3m during the six months to 30 September, while pre-tax profit doubled to £5.2m.
I don’t expect this rate of improvement to be maintained, but broker forecasts suggest Record’s earnings could rise by 20% in 2022. In the meantime, the group’s balance sheet looks rock-solid to me, and the stock boasts a generous 6% forecast dividend yield.
Record looks good value to me at current levels. I’d consider buying this penny stock for income and growth.
Still going strong after 157 years
Investing in old companies isn’t a guarantee of success. But, in my experience, businesses that have been trading for more than 100 years often have some attractive qualities. Renold (LSE: RNO) is one such firm. This business specialises in industrial chains and gearboxes — technology it’s been developing and perfecting since 1864.
Growth hasn’t always been in a straight line. Major customers in the mining and construction suffer cyclical slumps from time to time. Demand for some products has changed over the years. I suspect the shift to electric power and renewable energy will create fresh challenges.
Renold’s revenue and profits have fallen over the last two years, in part because of the pandemic. However, half-year figures for the six months to 30 September suggest the business has returned to growth. Revenue for the period rose by 17% and adjusted operating profit was 41% higher.
Broker forecasts suggest this growth should continue into 2022/23. With Renold shares trading on just eight times forecast earnings, I’d be happy to buy the shares for my portfolio.
A special situation with a 6% yield
Newspaper and magazine distributor Smiths News (LSE: SNWS) is in a special situation. The company’s valuation reflects this — the shares currently trade on just four times 2022 forecast earnings and offer a 6.3% dividend yield.
If this was a healthy, growing business, I’d probably expect a P/E of 8-10 and a yield of 3-4%. The problem is that printed newspaper and magazine sales are in long-term decline. These days, this stuff gets published online.
However, Smiths News has a 55% share of the remaining market. This makes it big enough to be profitable and cash generative.
The company says it already has plans to cut costs to match falling volumes. Brokers who cover the stock have bought into the story. They expect earnings to rise by 3% next year, pricing the stock on 3.9 times forecast earnings. Another chunky dividend is expected, indicating a potential yield of 6.3%.
The main risk I can see is that the business will keep shrinking unless management finds new markets for Smiths’ distribution services. At some point, which is hard to predict, this shrinkage could start to threaten the company’s viability.
My view is that there’s probably an opportunity here. For this reason, I’d be happy to open a small position in Smiths News today.
A penny stock turnaround?
Doorstep lender Morses Club (LSE: MCL) is expanding steadily into online lending and banking. The company focuses on customers with bad credit ratings, providing loans and pre-paid debit cards.
The pandemic caused revenue and profits to fall sharply, but Morses now appears to be on the road to recovery. The group’s loan book rose by 8.5% to £60.3m during the six months to 28 August, while pre-tax profit for the period rose from £2.3m to £2.6m.
This business will face ongoing regulatory risks, in my opinion, as I expect the rules on bad credit lending will continue to tighten. The impact of this could be that Morses’ profitability will be lower in the future.
Even so, Morses Club has a successful track record in this sector and a significant share of the market. Profits are expected to rebound in 2022/23, leaving the shares on just six times forecast profits. At this level, I see this penny stock as a potential buy.