Using artificial intelligence (AI) tools like ChatGPT to discover and recommend penny stocks can be quite intriguing. It has a habit of picking some pretty wild and volatile ideas that make for terrible investments.
However, despite this unreliability, it can occasionally shine a light on under-the-radar enterprises that rarely make it into the media headlines. As previously hinted, most of the time, the businesses ChatGPT recommends are tiny for a good reason. But every so often, it’s possible to stumble upon companies with promising potential.
With that in mind, I asked ChatGPT which penny stocks it thinks are the best buys in May. And after filtering out the results of companies trading above £1 and a market-cap greater than £100m, it put forward Litigation Capital Management (LSE:LIT).
So is this another wacky idea from ChatGPT? Or could it be a promising investment opportunity?
Understanding the business
Litigation Capital Management, or LCM, is certainly a unique business. Instead of investing in a portfolio of products or services, it invests in lawsuits and legal battles. Large corporations typically have their own in-house team of legal experts or have a law firm on retainer. But for small- and medium-sized businesses, that’s an expense that most can’t afford.
This is where LCM can be a powerful ally. Let’s say a rival infringes upon intellectual property or steals trade secrets. Borrowing money from a bank to fund a legal dispute in court is too risky. So instead, a small business can go to LCM to ask for funding.
After reviewing the case, if LCM thinks there’s a high chance of success, it offers to cover the costs, making the process entirely risk-free for the client. In exchange, LCM receives a chunk of the financial damages, recouping their initial investment as well as a profit.
What could go wrong?
Given LCM’s taking on most, if not all, the financial risk when investing in a litigation project, earnings can take a nasty hit should the courts rule unfavourably. There’s also the duration and liquidity risk to consider. Some lawsuits can take years before a resolution is made. During that time, any invested capital’s locked up. And with legal costs piling up, even a successful resolution may not end up being profitable.
These risks are particularly problematic for LCM’s largest four projects which currently make up half of its current investment portfolio. To be fair, this concentration issue has been slowly reduced through investment diversification. Nevertheless, it remains a prominent threat.
A good penny stock to buy?
The group’s track record of funding successful legal disputes appears to be relatively solid. However, the lumpy nature and timing of these investments can translate into periods of losses that lead to see-saw-like share price movements.
Nevertheless, litigating financing has little correlation with the broader economic market, making this penny stock an interesting way to diversify a growth portfolio. There’s no denying this is a high-risk, high-reward endeavour. But in the long run, so long as management doesn’t suffer a prolonged string of legal and financial losses, LCM appears to offer an interesting growth opportunity.
Does that make it a good penny stock to buy now? That depends on individual risk tolerance. But for those happy to hold through volatility, LCM seems worth further analysis, in my opinion.
