Buying a penny stock when it’s already dropped substantially can be a risky move. It could always fall further, and my investment could quickly unravel, risking a permanent loss of capital.
However, I stand to profit handsomely if a strong rebound occurs after I invest. This is especially true, I feel, if we can identify why the stock is down in the first place and assess whether the dark clouds are temporary.
In the case of the following penny stock, I think there is the potential for a huge recovery in the share price. Here’s why.
Hollywood strikes
The stock I’m talking about is Zoo Digital (LSE: ZOO). It provides creative media services, including dubbing, audio description, translation, and subtitling, to major Hollywood studios and streaming platforms. These include Disney, HBO, and Sony Pictures.
In just five months, the shares have crashed 70%. This has left the Sheffield-based tech company with a market capitalisation of just £61m.
In July, the company delivered a trading update that sent the share price crashing 28% in one day. The reason for the sell-off was that revenue fell in Q1 due to two issues.
First, the Hollywood writers’ strike has been going on since 2 May. The walk-out is over pay and the threat of artificial intelligence (AI) replacing content creation. Actors have now joined the strike, effectively putting a freeze on the creation of all new content in Hollywood.
This is now having an impact on the level of localisation and media service work on new titles, which is hurting the company. However, management expects these to be “short-term market factors“.
The second issue is that its customers are cutting costs as advertising spend weakens. Plus, there’s the ongoing transition of the global entertainment industry from traditional television towards streaming. The problem, though, is that most streaming businesses still aren’t profitable, putting further pressure on budgets.
However, Zoo’s management thinks these cost reductions will enable it to take market share as customers favour it over smaller niche vendors. And it expects revenue growth to resume in the second half of FY2024 (the company’s financial year ends on 31 March).
These problems could be temporary
Prior to these interruptions, the company recorded four years of impressive top-line growth. Revenue increased from $28m in FY2019 to $90.3m last year. And FY2023 adjusted EBITDA doubled year on year to $15.5m.
But the recent share price weakness has left the stock trading on a price-to-sales (P/S) ratio of 0.88. That is incredibly cheap for a growth company increasing its annual revenue by double digits and still expanding internationally.
Plus, the company is financially strong with a net cash position of $23m at the end of June. This means it has enough cash to ride out this rocky period without taking on debt or diluting shareholders while the stock is down.
Of course, we don’t know how long the Hollywood strikes will last. But if they persist, that may force streaming platforms to acquire non-English content. That could drive demand for Zoo’s dubbing, translation, and localisation services.
If the headwinds the company faces prove to be temporary, the share price could rebound very strongly. After all, the shares were at 207p as recently as March. I’m very tempted to buy.
