People often think the best penny stocks to buy are the cheapest ones. They surely have the most to gain, right?
Well, maybe not. There are many under a penny, but they sure didn’t start out like that. No, something has to go wrong to send them so low.
This brings me to something far more important than how big the gains might be. It’s the size of the possible loss.
The biggest loss we might suffer is always 100%. And I think the very cheapest could be the ones with the most chance of that happening.
Penny stock criteria
To pick penny stocks, I use the same criteria as with any others. I have to think they’re undervalued. And I must see strengths in a company, with a convincing reason why it can recover.
Take Shoe Zone shares. In 2020, they crashed to 35p, hammered with the whole retail sector.
But after one year of loss, profit bounced back in 2021. The firm had a good business model, selling essentials at low prices. And that can help a lot when inflation runs high. There’s still retail risk, for sure, and smaller firms could suffer.
But the stock valuation still looks low to me, with a 4.8% dividend. The shares? Up to 240p now.
The new hot thing?
Not everything with what looks like a good model works, though. Kodal Minerals springs to mind.
Lithium stocks have been popular. And news of a funding deal with a Chinese miner in early 2023 sent the stock flying. It helped push the market cap over £200m, but it’s back at £75m now, with the shares at 0.33p.
I don’t know if Kodal is a buy now, but I take one lesson from it. Buying into the latest big thing can be extra risky with penny stocks.
Another winner
Back to a winner, in the shape of Card Factory. The firm does greetings cards, as the name suggests, and small gifts and related items.
That’s all popular stuff in the UK, though the pandemic took its toll. The shares fell below 30p in 2020, but today they’re up at 108p. The firm posted a loss in 2021, but it’s since come back to rising profits.
There’s inflation risk here, for sure, and that could hurt the share price. But with a forecast price-to-earnings (P/E) ratio of only 7.7 with earnings steady, this might be a top class company at a very nice price.
A penny stock for today?
I’ll finish with one that’s still a penny stock, but only just. It’s Michelmersh Brick Holdings. At the time of writing, the shares trade at 98.8p. And the market cap is £92.7m, just a shade short of the usual UK penny stock limit of £100m.
In November, though, the shares were at 75p. And right now, we’re looking at a forward P/E of 10, and a 4.6% dividend yield.
I see volatility this year. But this is generally what I look for in penny stocks — a solid, boring, business on an attractive valuation.
The post These red-hot FTSE winners were once penny stocks, and they could have more to give appeared first on The Motley Fool UK.
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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
