Can Buying Penny Stocks Really Make Me Richer?

My first exposure to the stock market was when I started my first job and one of my new colleagues asked me if I wanted to join their penny stock club.

He told me all about finding multibaggers and getting rich quick. A stock that’s falling in pennies must have more potential than a stock that’s already gone up, right?

It sounded like they were buying failing stocks simply because they were down and hoping. I politely declined. Was I right?

Low priced stocks

I’m sure I was right not to join them. But I also believe it’s wrong to ignore penny stocks because of their potential danger.

I would say that penny stocks, carefully selected for valuation and long-term perspective, have the potential to be as profitable as any other.

Let’s look at one of my favorites, Michelmersh Brick Holdings (LSE: MBH). Technically, it is a penny stock with a share price of 97.25p below the 100p mark. The market capitalization of £91m is within the usual £100m limit.

Back to growth

However, in the past it was much lower. In 2009, Michelmersh shares fell to around 10p, near the bottom of the penny stock barrel.

But for me, the only thing that matters is the valuation.

Everything related to construction has been under several years of pressure. Michelmersh is expected to report a decline in earnings per share (EPS) this year.

However, it still places the stock at a modest price-to-earnings (P/E) ratio of 13.5. And according to forecasts for 2026, this number may drop to just 10.

Cash flow

The risk is still high here because we do not know when construction will start. And if earnings and cash flow don’t match expectations, the dividend could come under pressure.

Oh, there is a dividend, forecast at 4.6%.

However, cash flow was weak in the first half, falling 88% to just £0.9m. However, it is still positive. And let’s hope this will be the weakest year yet.

The company has reached the halfway point with net cash. It was just £4.1 million, down from £11.8 million a year earlier. But at least we’re not looking at additional debt risk.

Good penny stocks

This is just one example that I think shows what I look for when trying to reduce the risk of buying penny stocks.

First, I really want to see a profit. Some currently loss-making companies may be poised for a rebound and a strong future. But losses only increase the danger.

I also like decent cash flow, and that’s probably Michelmersh’s biggest weakness right now. However, a well-covered dividend is a good sign.

I also want to see a simple business in the market with good long-term potential. And I will stay away from anything that is heavily influenced by retail sentiment, for example.

Dangers

I don’t want it to sound like I think penny stocks are all sweet and light. No, I always think back to a highly speculative product that I once considered for a penny or so. How much more can it fall? Today it is about 96% lower.

When it comes to penny stocks, I suggest being especially careful with tomorrow’s jam stocks.