There is something to be said for penny stocks. Owning a piece of a company at a dirt cheap price sounds like a great idea. But I think it is important to consider a whole lot of other things before buying penny stocks.
Penny stocks may not be bargain buys
One of them is the long-term share price trend.
Let me give an example here. Consider the share price of the FTSE 100 company Spirax Sarco Engineering. Right now, its share price is over £140, making it the most expensive stock listed on the London Stock Exchange. If I had £1,000 to invest, I would be able to buy only seven shares in the company.
On the other hand, another FTSE 100 stock, Lloyds Bank, has a share price of 43p. With the same £1,000, I can buy a whole 2,325 shares in the company. If that were my only basis for deciding the best share to buy, the Lloyds share price would look so much more attractive!
But, if I look at the five-year share price performance for both shares, the odds tilt in favour of Spirax Sarco. The engineering biggie has seen a 273% share price increase in the past five years. By comparison, the Lloyds share price has declined by 25% over this time. In other words, I would have made some serious gains by buying the pricey stock and would have lost money on the penny stock.
It follows that holding far fewer shares of Spirax Sarco would have been a better bet than buying Lloyds Bank shares. Of course, it does not mean that this will happen in the future. Things can change. It only means that a penny stock is not always a bargain buy.
It may just be a good buy!
At the same time, there is a possibility that it can be a good buy. For instance, I bought Cineworld shares at sub-100p levels because I see value in the stock. The FTSE 250 cinema chain was compromised severely last year as its operations were limited and it took on debt to continue.
But I believe that it can come back once the corona crisis is well and truly behind us. In fact, I expect that its share price will start rising as the crowds get back into cinemas and that starts showing up in its numbers. However, for now, the share has tumbled to 58p, which is around a third of its pre-pandemic price. In my view, its drop to penny stock levels indeed makes it a bargain buy.
Here, I am not trying to advocate buying Cineworld shares or not. I am only driving home the point that a penny stock can hold value in an investor’s eyes.
Would I buy penny stocks?
The big point here is the following. It matters less whether a stock qualifies as a ‘penny stock’ or not to make it worth buying. Ultimately, I only need to consider whether it will give me good returns over time.
Manika Premsingh owns shares of Cineworld Group. The Motley Fool UK has recommended Lloyds Banking Group. 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.