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Your Money > Investing Comment Articles > Pennies from heaven...
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By Richard Hunter, Hargreaves Lansdown Stockbrokers
As the legendary American investor Warren Buffett observed, "Price is what you pay. Value is what you get." And there are still investors who are seduced by the fact that simply by having a low share price, there must be a killing to be made on a company ahead of the crowd. Over the years, "penny shares" have had a fair amount of bad press and have largely contributed to the incorrect notion that the stock market is little more than a casino. So is the reputation of penny shares justified and what has brought it about? Even the definition of penny shares is a little blurred. Initially they were generally regarded as any company where the share price was less than £1, whereas nowadays anything up to around £3 seems to cover the "sector". Additionally a low market capitalisation (say less than £100 million) can be used as a barometer. The regulator, the Financial Services Authority, has its own definition, namely that they are shares with limited liquidity, in other words they can simply be more difficult in which to deal. Whatever the definition, they are certainly typified as being younger, less established companies perhaps even without an established earnings record. They may be niche specialists (such as biotech companies or high tech) whose business is pretty much focused on one product or development line. Furthermore, the wide spreads which are often quoted can eat into an investor's return, resulting in an immediate loss on the transaction. There is likely to be a reason for a "low" share price, accounting issues aside. For example, the company could be out of favour (a recovery stock), on the way out completely, failing in its market, or a cash shell. The investor therefore needs to ask whether the current share price valuation is justified, for example - does the business have a leading position in its own market, and is that market one with much growth potential? Are the earnings and announcements coming from the company visible and regular? Penny shares continue to have a shelf life because of their speculative appeal, linked to their low value. As such, the investor will need to consider his/her attitude to risk, since these tend to be at the higher end of the risk spectrum. And, as with any other investment, the investor should do his/her own research and understand the market in which the company operates. This is not to say that there are no success stories - far from it. Indeed, many of the current FTSE100 companies will have matured from once being penny shares, although by the same token there will be many more which did not make the grade. And for all their lack of liquidity, there are some pointers which more hardy investors can consider when investing in these shares. One would be to look for shares where the net asset value per share is higher than the current share price - this would reflect that the company is solvent after taking its liabilities into account, which could help either in the event of a downturn or if the company wished to raise more capital for expansion. Also, it is preferable to be thinking about stocks, rather than sectors or trends, in this space. Any specialist knowledge which the investor might have, be that through the field in which they work or a topic in which they have a particular interest, may provide an edge. In all, oak trees do indeed grow from acorns, but in this dynamic area of the market the investor must, as ever, do their research and enter with their eyes fully open. Useful links: |
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