1 penny stock I’d avoid like the plague right now

Despite this penny stock skyrocketing in value on the back of AI excitement this year, I’d still avoid the small-cap at all costs. Here’s why.

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Penny stocks can provide tremendous returns for investors, but they also carry huge risks. And one small-cap stock I would steer clear of right now is RC365 (LSE:RCGH). Despite skyrocketing earlier this year, the share price looks poised to plunge.

Overvalued with no fundamentals

The RC365 share price is up 110% this year. This has led many investors to believe it has the potential as an artificial intelligence penny stock to rival Nvidia‘s monumental gains. However, RC365 is actually just a payments company. It actually has little real exposure to artificial intelligence (AI). This is why certain investors have labelled it a meme stock.

With price-to-sales and price-to-book ratios of around 70 and 30, respectively, RC365 shares are fundamentally overvalued. This is especially the case when the company is unprofitable with less than £2m in revenue to show for it. For a fledgling business bleeding cash, these valuation multiples make absolutely no sense fundamentally.

Opaque financials

Aside from that, the firm provides little transparency into its financials beyond basic top-line figures. The lack of details on segment performance, costs, cash flow, and outlook makes it nearly impossible to accurately value the stock.

This opacity enables speculative hype — rather than fundamentals — to drive the stock price. As such, it’s a recipe for volatility and potential disaster when reality sets in. This is something most novice investors would have experienced during the 2020/21 bull market. Numerous SPACs and penny stocks went public with lofty valuations that were based purely on hype, only for them to lose most of their value in the months and years that followed.

For investors, the inability to accurately value this stock due to the lack of financial details is a bright red flag. It results in hype and hearsay to fill the information vacuum as the share price disconnects further from any reasonable valuation, as has been the case in the year to date.

I’d steer clear

While the RC365 share price could keep rising in the short term, it seems like any gains are going to be likely driven by hype rather than financial performance.

Huge insider ownership is another red flag for me. After all, CEO Chi Kit Law holds nearly 70% of the shares. This concentration poses major risks, as the share price could plummet rapidly if he starts selling, especially considering the rise of the stock this year.

Moreover, it indicates that very limited floats and liquidity exist in the market for other investors. Hence, any change in insider sentiment could have an outsized impact on the stock volatility.

Of course, the company itself could go on to do great things, but I’d only invest once I started to see that happening and at a more sensible share price.

But for investors who are seeking exposure to AI, higher-quality, larger-cap tech stocks are much safer investments. I see better underlying investment cases in other stocks such as Nvidia and TSMC which could grant me similar returns in the medium-to-long term.

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 assessed. Consider taking independent financial advice.

John Choong has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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