Penny shares get a bad rep, and this is for good reason: the vast majority of them make poor investments. The FTSE All-Share index is packed full of companies that are doing literally nothing – big traps for your money. And this is compounded by the fact that there are no FTSE 350 shares priced in pennies as yet – in fact, 50p (Debenhams) is about the cheapest you can pick up a share of a well-known company.
One of the basic mistakes shareholders can make is to simply assume that because something is priced in pennies, that is must be a poor company. Or that simply because something is priced in pennies, that the company valuation must be cheap. Neither are particularly true, even the most expensive FTSE 100 company by share price could get its share price into the penny range by issuing enough shares.
Shares at the cheaper end of the portfolio offer some decent upsides for investors, for example:
- In absolute terms, they are cheap, allowing some small exposure
- Prices at the low levels have higher leverage. A jump from 4p to 5p is 25%, the equivalent of another share jumping from £100 to £125
- Many firms behind these type of shares represent speculative investments, with greater possible returns than safer, defensive shares.
- They can be incorporated as part of a balanced portfolio with respect to risk.
I should add that virtually the same standards you make for buying normal shares should apply to penny investments. You still have to like the proposition, and you have to believe in the story its telling you, and more importantly, you have to like the price it’s coming to you at.
Chosen correctly, there can be massive capital gains, but there in lies the difficulty. It isn’t easy to choose, and if we applied the advice that comes with normal trades, we probably wouldn’t buy this at all. You know how people say it: everything has to be going for the share, we want a share with durable competitive advantage, and so on. With smaller companies, it’s almost impossible to have it all this way. Even if we looked at current stars Amazon or Ebay when they were just starting out, there would have been the same doubts. Both had plenty of competition, after all, and both were capital intensive in their growth phases, which would have been enough to put people off.
So, that’s how I’ve come across Aukett Swanke. They provide architect and interior designs to a range of high-end clients and have an impressive range of projects behind them, mostly in the UK. A 3p share price gives a market capitalisation of under £6m, which is pretty impressive seeing as profits used to be in the region of almost £2m, there is a cash balance of almost the same, and there is also little debt.
So why the nervousness in the market? Firstly, profits have dipped this year to just under £1m. Essentially, business has not been as brisk in the UK, but certain skills have had to be retained within the business otherwise you cannot go out and get new business. And we can see that £1m does not really buy many skilled architects.
Despite the sound profits (profitable five years in a row), one of the main concerns priced in is that it might go bust. Unlike a massive company such as an airline who can run up massive debts secured by assets, there is no such thing here. A disastrous year where no work came in would more than likely see them quickly run into debt. For a company of this size (£20m) , there would be few funding options here. The type of work taken on is transactional and not recurring, which makes it hard to predict the future.
To prevent the company being totally reliant on one jurisdiction, they have diversified geographically using acquisitions and joint ventures. They operate in several companies and the overall footprint including partners is a much larger one than the reporting entity.
So can this be considered a good investment? At current prices I am more than happy to take this up on a very low PE. The worst case scenario may be a ‘hard Brexit’ in which virtually all developments halt, but I see this as unlikely. Even if this was the case, the interior design business can be lucrative and a potential source of income that can be regenerative, with companies, especially the larger ones requiring this type of service fairly often. Whilst its true that their share price has not been above 10p in 10 years, they appear to be managed well with sensible goals. I think they could even survive another lean year next year, but if there is signs of that occurring management will start chasing other targets to generate cash.
Disclaimer: I’ve bought into Aukett Swanke; please do your own research before you do.