Penny stocks are commonly mispriced. Sometimes, the market overvalues them, which means I stay away. But often, great companies are selling for much cheaper than I think they’re worth. These are the shares that I seek to buy.
56% growth in a year forecast
One I’ve been watching for a long time with its shares selling for below £1 is Michelmersh Brick Holdings (LSE:MBH). This business manufactures premium, long-lasting clay bricks, tiles, and other related products.
It has a strong dividend yield of 4.6%. Furthermore, the average 12-month analyst price target is £1.52, indicating 56% potential price growth. While that’s not guaranteed, that would be an absolutely massive short-term return.
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Of course, as a Fool, I only look for long-term investments. I believe at its current valuation and with its strong dividend yield, these shares are worth me buying and owning for years.
Over the past decade, the company has had a price-to-earnings ratio of 16.7 as a median. Today it’s a far lower 11.4. Analysts estimate its earnings will steadily increase again in 2025 after a recent contraction in 2024.
When growth slows momentarily and prices fall, that’s when I buy. After all, it’s Warren Buffett who taught us to “be greedy when others are fearful, and fearful when others are greedy”.
What risks do I face?
The greatest area of weakness with the company I’ve noticed is that it has very weak free cash flow at the moment. This means that it could struggle to finance new expansion strategies, as that’s the money it has left over after paying for all operating expenses and equipment.
I expect this to improve next year as the Bank of England is likely to cut interest rates soon. This should improve demand for Michelmersh’s products as people can finance new building constructions with less borrowing costs.
Furthermore, I have to remember that this isn’t exactly the next Nvidia. Michelmersh’s price has only risen 39% over the past 10 years. However, its the low valuation that analysts think could boost its price so much in the next year.
Despite this near-term growth potential, I expect the shares to grow much more slowly over the next decade. There could even be periods of decline, so the dividend yield is really important to me.
Stability over excitement
My favourite investor, Warren Buffett, is slow and stable in his investment approach. Rather than seeking quick gains from exciting new fads, the Oracle of Omaha looks for strategic long-term businesses that the market is undervaluing.
While Michelmersh Brick Holdings isn’t as strong as some of Buffett’s best investments of all time, it’s certainly well-positioned right now. Because its balance sheet is also strong and it has very low debt, I feel comfortable owning the shares and intend to hold them for many years.
The following chart shows that the company currently has £222m more in cash and equivalents than total debt:
A stellar long-term buy
To me, the strengths far outweigh the risks here. I’m likely to buy shares in the company in the next month. I hope I get them before the valuation potentially starts to climb!
