Penny shares sound like a good thing. And they can be. After all, there’s surely less risk investing a few pennies in a share than investing a few pounds, right? And a penny share must have the potential to climb further than one that’s already way up on the price scale?
Well, no, I think those are two of the biggest mistakes investors make. I do think investors can pick up some great buys when searching round shares on very low prices, but we need to be careful.
The price alone tells us nothing about the value of a penny share. Imagine a company with shares priced at a pound. It could do a 10-for-one stock split, and create 10 times as many shares priced at 10p each. Suddenly it’s a penny share. But it’s exactly the same company.
Less downside with shares that are already on very low prices? A 10p share would offer less risk than a £1 share — for an investor only buying one share. But if we’re investing a specific sum, the risk remains the same. The maximum we can lose is 100%.
Market cap is key
Investing in penny shares can actually be riskier than more highly priced ones. It depends a lot on the size of the company, or its total market capitalisation.
Take Lloyds Banking Group with its shares priced at 42p, on a market cap of £29bn. Compare with an oil explorer that has yet to make any profits, and has a market cap of only £20m. Even if its shares also trade at 42p, I know which one I think has a greater risk of going bust and losing all my money.
In one sense, a penny share price is just a share that costs less than a pound to buy. But in the wider investing world, they’re typically thought of as low-priced shares that are in companies with very low market cap valuations too.
Bad penny shares?
I avoid the latter. Over the years, I’ve missed some good profits. I’ve seen people buy shares at fractions of a penny each, in tiny companies with very low market caps, and go on to make big profits.
But at the same time, I’ve avoided many more that have gone bust. When a company floats on the stock market, nobody thinks, “It’ll be great if we start the shares at a penny each“. No, it usually takes years of poor performance to get down there.
But buying shares trading for pennies, in good quality large companies that have fallen on hard times? Now that is something I go for.
Good penny shares?
Right now, I still think Lloyds shares are cheap. I also suspect Rolls-Royce shares, at 87p at the time of writing, are unlikely to remain below £1 for much longer.
There are risks specific to these two, for sure, notably from our economic outlook and the pressure that’s still on the aviation business.
But if I search for shares priced at under £1, in companies with market caps of at least £50m, I do see a lot that I like.
