Penny stocks are notorious for being high-risk. And for a good reason. All too often, these shares explode on investor excitement only to collapse on disappointing results.
But every once in a while, a hidden gem emerges and grows enough to leave penny stock territory and become a small-cap.
Investing in the latter is still risky. But the businesses are more established and proven, making an investment less speculative.
And one such company that has caught my attention this week is Science Group (LSE:SAG). Its share price is up nearly 60% over the last two years and could be primed for stellar growth when a new bull market emerges.
A top-notch ex-penny stock?
Science Group is an international science-led service and product development company. It works with businesses to consult on R&D projects, helps with regulatory compliance, and is a leading supplier of DAB/DAB+ radio chips.
It’s a pretty diversified enterprise for one that’s only got a market-cap of £177m. However, its services have proven invaluable to many industry leaders. For example, Science Group helped AstraZeneca develop an automated drug identification system. And it also assisted Vodafone in building its M-Pesa mobile payments solution that over 51 million people are using today.
Moreover, management’s latest decision to acquire TP Group could bolster its reach even further, throwing defence into the list of sectors it serves. Given its impressive track record, this move seems prudent. After all, it opens the door to government and military contracts that can be a reliable source of long-term income.
Over the last five years, Science Group has been quietly delivering double-digit revenue and profit growth, with margins slowly expanding. And this may be set to accelerate as we enter into a new bull market. After all, once economic conditions improve, spending on R&D is likely to increase, raising demand for the ex-penny stock’s services.
Investigating the caveats
As promising as Science Group looks, there are, of course, notable risks to consider. In the long run, management needs to ensure operations stay ahead of the regulatory curve. If out-of-date compliance advice is given to customers, it could have severe legal and reputational ramifications.
But there’s a more pressing concern in the short run. TP Group is a distressed business plagued by onerous legacy maritime contracts. These contracts are being renegotiated but, in the meantime, it has completely decimated the firm’s profitability.
Science Group’s decision to acquire it seems to be a turnaround play. And if successful, it could prove to be a tremendous source of long-term value. But the process may take some time. And a poorly executed strategy could harm the success of the ex-penny stock to date.
Having said that, the leadership team has proven to be shrewd, so far. That’s why I’m cautiously optimistic about the deal. And in the long term, I believe patient investors could be rewarded generously.
