Penny stocks are often associated with volatility and high-risk. With tiny companies that can be true. But by carefully picking and choosing shares, I try to find the greatest growth potential stocks with the lowest risk.
Finding the best penny stocks
There are over two thousand shares listed in the UK. Penny stocks, or penny shares, are described as those that trade under £1. By filtering down to this price range, I can narrow down my list to 866 companies. That’s still quite a lot so I’d need to find some other criteria to shrink the list further.
I tend not to look at shares that have a market capitalisation of under £50m. I find many of these very tiny companies are illiquid and often too volatile for my risk appetite. Filtering for market capitalisation, my list falls to 327 companies.
Finally, I’d like to see an element of profitability and quality. For this I’d want to see at least a positive return on capital employed. The greater the better, in my opinion. My list is now down to 89 penny stocks. I reckon that’s much more manageable for me to dive deeper and try to find the best ones.
Diving deeper
One of the greatest things I like about smaller companies is that they’re often under-researched by analysts and investment banks. They can be too small and too illiquid for large funds to invest in. That’s not much of an issue for private investors like me. I actually think it’s a great opportunity to discover hidden gems.
So once I’ve narrowed down my shortlist of penny stocks, it’s time to do some further research. This involves reading more about the companies from a variety of sources, including The Motley Fool.
When researching a company, I’d want to know what could drive the share price higher. Among several other factors, it could be a new product, renewed business strategy, or a change of management. I’d like to see steadily growing earnings and a solid balance sheet too.
All of these points can help build a picture of the company and its prospects as an investment.
Shortlisting the shortlist
There are a few companies for 2022 that I’ve got my eye on. Some of those that meet my criteria include Air Partner, finnCap, and MTI Wireless Edge. All three have a return on capital employed of over 15%. I reckon that’s pretty good. They all also demonstrate rising earnings growth. Lastly, all three offer a dividend yield of 3%-4%. In the current climate of low interest rates, I’d say that’s pretty good.
A word of warning however. If I bought any of these penny stocks, I think I’d need to be a very patient investor. They are very small companies and their share prices can often take some time to move higher. But once they move, they can move quite quickly. This can be the case on the downside as well as the upside. So I would only invest what I could afford to lose and would spread my investment across several companies to reduce my risk.