How to get rich buying penny shares… or lose money trying!

Penny shares, those priced at less than 100p, have been popular with investors for years. Are they really such a good bet?

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British Pennies on a Pound Note

Image source: Getty Images

When we invest in shares, we want to buy low and sell high, naturally. And it’s tempting to see very low-priced penny shares as having greater potential for gain. After all, an AstraZeneca share at £10 has to gain £1 just to make a 10% profit.

But Premier African Minerals shares cost just 0.35p. It would only take a 0.5p gain to more than double our money with that one. And the chances of a halfpenny rise must be far higher than a full pound rise, yes? Well, maybe not. I think investors can make good money from penny shares. But they can also lose a packet.

It’s easy to think there’s less to lose with a penny share, even if it doesn’t turn out to be a big winner. But that’s a big mistake. Whether I invest in a high-priced FTSE 100 stock, or in penny shares on the AIM market, my biggest possible loss is exactly the same. It’s 100% of my money.

Big winners and losers

We’ve seen some spectacular penny stock gains over time. Twenty years ago, Apple sold at 80 cents (64p) per share. There have been a number of stock splits since then, but investors who bought and held are sitting on a gain today of around 45,000%.

Then again, I’ve seen some astonishing falls over the years of my investing career. I can count a number of oil and minerals explorers whose shares once traded for tens of pennies, but which went bust, or fell to less than 1p. It’s all about valuation.

Which penny shares would I buy today, and which would I shun? Let’s look closer at Premier African Minerals. At 0.35p, it’s up 98% over the past 12 months. And it’s risen 220% over two years.

Longer term

But that’s the very recent picture. Since listing on AIM back in December 2012, the stock has plummeted by 84% overall. The intervening years were packed with fundraising, including equity issues that have led to massive dilution for early investors.

Right now, the excitement is all about lithium, in big demand for batteries. But the company is still digging and still has no revenue stream. Maybe profits are just round the corner, but the risk is way too high for me.

I prefer to steer clear of sub-penny shares and go for established profitable companies that have fallen on (hopefully) temporary harder times.

Top-drawer penny shares

My prime example is Lloyds Banking Group. At 45p, Lloyds is firmly in penny share territory. I’m holding because it’s nicely profitable and is paying me dividends. Lloyds faces economic risk, but I think it offers good long-term value too.

Then there’s a very popular penny share today, Rolls-Royce. Rolls shares have been picking up of late, but they still just squeeze in at 92p. I haven’t decided whether I’d buy this stock.

But whichever penny shares I buy, I’m looking for profitable companies at attractive valuations. I reckon that’s the best way to build long-term wealth. Super-cheap penny shares in unprofitable companies are usually too risky for me — but I’ll still keep my eye open for them.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Alan Oscroft has positions in Lloyds Banking Group. The Motley Fool UK has recommended Apple and Lloyds Banking Group. 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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