My guess is that when most people think of penny shares, they think of small businesses.
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And I reckon small companies with a potentially long runway of growth ahead of them, can make promising long-term investments. But they do tend to come with enhanced volatility and risks.
Volatility, risk and opportunity
However, that volatility is part of the appeal of small companies as well as part of the additional risk. Indeed, it’s not uncommon for small stocks to shoot up 25%, 50% or even 100% in short order if trading results come in ahead of expectations. Or if a major contract win or other event enhances the firm’s forward-looking prospects. But the reverse is also true. And small stocks can fall by similar percentages on bad or lacklustre news. Often those moves are so fast there’s no time to react by selling or buying shares.
But the dream of many investors is to pick a small business and see it grow over several years while they are holding the shares. That’s part of the approach that delivered such impressive results for investors such as Lord John Lee. And he detailed his strategy in his book How to Make a Million — Slowly. I think the book is a great read and it’s helped me with my own approach to investing.
I wouldn’t go all-in with any small business. But there’s room in my portfolio for a handful of tiny companies. And my way of aiming to mitigate some of the risks is by investing smaller amounts of money in little companies than I do in large ones.
However, searching for small businesses becomes problematic when I focus on the term ‘penny shares’. And that’s because one popular definition suggests the term means companies with a share price under £1 in the UK and a market capitalisation under £100m.
A well-stocked hunting ground
There’s no issue for me with the market capitalisation being below £100m. That’s a good limit. And there’s a well-stocked hunting ground in the London markets for decent small companies below that level. But I ran a stock-selection screen recently and it turned up many promising opportunities.
However, many of the companies on the list had share prices above £1 even though their market capitalisations were below £100m. And that’s the problem for me with the term ‘penny share’. Small companies under £100m market cap can have all sorts of share prices — 12p, 78p, 155p, 768p. It doesn’t affect the actual size of the business as measured by its market capitalisation. Indeed, we can calculate a company’s market capitalisation by multiplying the share price by the total number of outstanding shares.
As an experiment, I deleted all the shares with a price above £1 from my screen. But the process eliminated the best-looking opportunities! So, to me, penny shares do not offer the best investment opportunities now. However, there are some great London-listed companies with market capitalisations below £100m and share prices above £1. And I’m watching many of them closely with a view to buying some of their shares to hold for the long haul.