There’s been a glimmer of light for the penny stock in more recent months. Precious stones prices have risen again as the economic recovery from 2020’s lows has kicked in. Fresh fundraising earlier this year, allied with an improvement on the production front, has also raised optimism over Petra Diamonds’ long-term future.

I’m still yet to be convinced to buy this stock however. I’m not just worried about how the recent resurgence of Covid-19 cases could impact the diamond market again. And especially what this would mean for Petra Diamonds, given that its balance sheet is still looking petty fragile. The patchy long-term outlook for the natural diamond market also gives me reason to be concerned.

Demand for lab-grown stones has been steadily increasing in recent years. And researchers at Statista expect the market to explode over the next decade. They reckon market volumes will stand at 19.2m carats in 2030. That compares with 6.2m last year and 1m carats in 2010.

It’s also possible that investor interest in Petra Diamonds’ shares will fall as the importance of responsible investing grows. Concerns over worker conditions in South African mines has, along with price, driven the popularity boom for artificial stones. These rising ethical concerns are something that could also drag the Petra Diamonds share price lower over the next decade. Today, the company trades at 1.7p per share.  

A better penny stock to buy

I’d much rather buy UK healthcare share Shield Therapeutics (LSE: STX) for my shares portfolio. This penny stock trades at 45p per share, and I think it could soar in value as the problem of iron deficiency explodes.

Shield Therapeutics’ leading product is Feraccru/Accrufer, a treatment for iron deficiency anaemia. Sales of the drug are rocketing in Europe, with volumes ballooning 51% in the first half of 2021 versus the final six months of last year.

Encouragingly, the pharma firm launched the product in the US on 1 July after getting regulatory approval there. And China has potentially opened the door to the drug being released in that gigantic growth market too, having recently received approved of a new drug application for Feraccru.

Remember that regulatory approval is, of course, by no means guaranteed in China (as is the case elsewhere). Thus, all the hard work Shield Therapeutics has carried out could fail to meet expectations. Still, I’m encouraged by the thumbs ups the penny stock’s product has received from European and American regulators.

I think the company’s work to treat a major global health problem could reap huge rewards.

A breakout UK small-cap stock

Surface Transforms makes carbon-ceramic brakes. Its proprietary method produces brake discs that are more durable and conduct heat better than its competitors. Surface’s main competitor owns almost all of the market, but the owners of BMW own most of it. Surface presents a compelling alternative for carmakers concerned about this BMW connection. 

After many years of trying to crack the market, orders are starting to grow. Surface won several new contracts in 2020. One of them – to be a sole supplier to a global customer – is a huge deal. To be a sole supplier, the customer must have complete confidence in the product and its delivery. Others will take note, and this could be the key that unlocks a chunk of market share in the future.

These new orders should push the company into profitability by 2021, and profits should continue to grow in 2022 and onwards. And I think there is more to come. The carbon-ceramic brakes market is worth around £200m and is growing. A 10% market share equates to revenues of over £20m per year – a significant improvement on the £1m in revenue reported in 2019. I think a 10% market share is achievable. So if you are looking to buy shares in a UK small-cap company, I think you should consider Surface.

Stock therapy

Shield Therapeutics is a pharmaceutical company. Its lead product, Feraccru/Accrufer, treats iron deficiency anaemia. Regulators have approved Feraccru/Accrufer and it is now commercially available. Getting past the approval stage and onto marketing and selling a drug is a significant milestone and reduces the risk of failure. Now the company needs to focus on increasing sales volume.

Shield finds marketing and distribution partners for the markets it wants to enter. The partners pay upfront and milestone payments and royalties on sales. Shield’s European partner sold more of the product in the first half of 2020 than in the whole of 2019. A deal with a distributor covering China, Hong Kong, Macau and Taiwan has been agreed this year and sales could commence as early as 2023.

Finding a US partner would be a game-changer for Shield, and could happen before 2020 is out. The deal with the Asian distributor is worth around £35m in upfront and milestone payments, and 10%–15% of net sales for at least 10 years. I would expect the US deal to be more lucrative. Combining European, Asian and US upfront payments and royalties on sales is expected to tip Shield into positive cash flow and consistent profitability from 2022 onwards.

Owning shares in Shield looks a lot less risky now. Getting to the point of actually making sales of a drug is a huge milestone. The next step is to scale up in existing markets and break into new ones. I think Shield is a UK small-cap stock to buy right now.

A promising start

Small-cap Shield Therapeutics (LSE: STX) floated on the AIM market last year and currently has a market cap of £183m. Shield’s plans certainly sound promising. The group’s main product is Feraccru, a treatment for iron-deficiency anaemia. The company is actively marketing Feraccru in Europe and has secured patent protection until 2035 in a number of markets, including the US.

Today’s half-year results provide an insight into progress. H1 revenues were £142,000 and the group reported a net loss of £9.6m. However, the company had net cash of £21.5m at the end of June, so there’s no imminent risk of a cash shortage.

According to management, the group’s strategy is to licence Feraccru in non-core markets and market it directly in major markets such as the UK. The company currently has 20 sales staff “driving product recognition and sales” in Germany and the UK.

Pack sales are said to have increased by 375% in Germany between December 2016 and July 2017. In the UK, growth over the same period was 184%.

2.5m patients?

The company is looking forward to the results of a phase 3 clinical trial in early 2018. If the results are as expected the company hopes to gain regulatory approval in the US. According to chief executive Carl Sterritt, this could increase the potential market opportunity for Feraccru from 330,000 patients to “upwards of 2.5m patients”.

It all sounds promising. But as investors we also need to consider the firm’s valuation. In today’s results, Shield reiterated its guidance for annual sales of £20m-£25m in 2020. My concern is that the group’s current market cap is already £183m.

This guidance means that in three years from now, the stock may still be valued at more than seven times sales.

This sky-high valuation seems to carry a high risk of disappointment. I won’t be investing.

An unlikely double-bagger

Shield Therapeutics may strike it lucky and attract a takeover bid. But I’d rather put my money into a proven performer.

Shares of British American Tobacco (LSE: BATS) have doubled since 2010. During the same period, the group’s dividend payout has risen by 50%. Patient shareholders have enjoyed a market-beating capital return and a generous dividend income.

Big-cap stocks don’t always perform this well. But BAT’s share price has now fallen by 17% from the all-time high of £56.40 seen back in June. The shares are starting to look more reasonably valued, in my view.

Earnings are expected to climb by 14% to 282.4p per share this year, and by a further 11% in 2018. Dividend growth is expected to be around 9% in both years — well above inflation and average wage growth.

These forecasts put British American Tobacco on a 2017 forecast P/E of 16.5, with a prospective yield of 4%. The recently-completed acquisition of Reynolds is expected to result in cost savings that should support margins. For investors wanting real returns on their investments, I believe BAT could be a profitable buy.

A lucrative startup?

The question must have crossed a few minds when reading today’s first-half results from Shield Therapeutics (LSE: STX), which floated on AIM as recently as February 2016.

Shield describes itself as a “specialty pharmaceutical company focused on the development and commercialisation of late‑stage, hospital‑focused pharmaceuticals.” It reported its first revenues, of £240,000, from sales of its iron deficiency anaemia treatment Feraccru after it was approved in February. It’s a modestly-priced medication, but chief executive Carl Sterritt described its pricing agreements as attractive, and sales should also commence in Germany in October.

It’s hard to put any kind of valuation on Shield’s 159p shares at the moment, as there are no profits forecast yet, and consistent losses pencilled-in for this year and next. The firm did have £28.4m in cash on the books at 30 June but with pre-tax losses of £18m-£19m per year forecast for this year and next, there’s going to be some more fundraising needed before any profits start rolling in.

Where does this leave Shield Therapeutics as an investment possibility? It’s not a total blue-sky punt as it does have a marketable product and does actually have sales cash coming in, but other than that I see it as pretty much straight gambling if you invest right now — it looks like one of those companies that could make you a very big profit it it comes good, but could lose you your stake if it doesn’t.

Tried and trusted?

Are you better, then, to stick with an established blue chip pharmaceuticals company like AstraZeneca (LSE: AZN)? AstraZeneca was struggling against the expiry of patents and increased competition from generic drugs when Pascal Soriot took over as chief executive in October 2012.

Mr Soriot’s shake-up was severe, and it was always going to take a few years to rein in the firm’s falling earnings and return them to growth. I’d optimistically hoped for EPS growth by 2017, but that seems unlikely now, with falls of 2%-3% forecast for this year and next. Still, if we see EPS growth in 2018, that really won’t be a bad turnaround result at all.

I’m a little surprised that the price has spiked by a third since the middle of June to 5,164p. That’s taken the shares to a forward P/E multiple of 16.4 for 2017, though interim results on 28 July saw second-quarter falls across the board. It was all in line with expectations, mind, and there’s really nothing new that wasn’t known six months ago.

I suspect the price recovery is simply down to investors re-appraising the value of good old safe and solid shares like our big pharmaceuticals players, partly in the sobering light of the EU referendum result. And they’re realising that P/E ratings of around 16 or so aren’t at all stretching for dependable investments providing dividend yields in excess of 4% and which should be generating profits for decades to come.

At least, that’s the way I see AstraZeneca, and it would nice to think the market does too.