Penny stocks are companies that have a share price of less than £1. This is the most straightforward objective definition. From a subjective point of view, some think that penny stocks are risky, small companies that are pushed as part of scams. Although some do fall into this category, I can filter these out by looking at penny stocks that have large market capitalisations.Â
Once done, I can then feel more comfortable in looking at companies that (aside from potential share price growth) could offer me some attractive dividend payments.
Opportunities aside from growth
The growth opportunity from penny stocks is one of the points that makes investors like me drawn to them. In theory, companies have a low share price for two main reasons. The first one is that the company is new and growing, with a potential for the share price to continue to push higher. Secondly, an established company might have seen the share price fall to low levels due to negative business developments or the impact of external factors, such as the pandemic.Â
Either scenario doesn’t rule out the potential to pick up some passive income via dividends. For example, Lloyds Banking Group is a penny stock, trading around 44p. The impact of the pandemic has seen the share price fall considerably from levels seen at the start of 2020. Yet in the recent half-year results, the bank confirmed resumption of a dividend.Â
Currently the dividend yield is 2.76%, which is slightly below the FTSE 100 average. However, it’s still above the 2% rate of inflation we have here in the UK at the moment. When I also compare this to the interest rate I’m getting on my cash accounts, the dividend yield is attractive.
Using the best of both worlds with penny stocks
Even if I’m not specifically looking for share price growth from penny stocks, it does help. For example, let’s say I invested in a penny stock that had a dividend yield of 3% which I held for three years. During this time, the share price rallied 20%. When I come to sell the stock, the profit from the share price can be seen as additional income on top of my initial investment.
So if I loosen my definition of income from shares, there is even higher potential when I look to penny stocks. The flipside of this also applies though. If I invest in a stock at 10p and the price falls to 5p, I’m down 50%. I’d need to hold onto this stock for many years before the dividend income would offset this loss if I sold it at 5p.
Overall, I think penny stocks offer me good potential as an income investor. Clearly, I can pick up dividend income (as long as the dividend is paid, which is never guaranteed). On top of this, if the penny stock does see strong share price gains, when I sell the stock I can treat the profit as an additional final income payment.