Penny stocks are a type of share with prices below £1. In theory, this is the only technical point needed for a company to qualify as a penny stock. Clearly, this doesn’t distinguish between the risk of the stock or other factors I’d need to consider before buying it. This lack of points needed for something to be termed a penny stock means that I shouldn’t just discount them due to the name. So here’s how I’d go about investing in such stocks with £100 a month.
Points to note with penny stocks
The big stigma that comes when I mention penny stocks is that of a scam or ponzi scheme. This idea dates back many years, and is often due to smaller companies with share prices of just 1p. Some dodgy stockbrokers would push small and high-risk stocks towards investors who didn’t know the risks of what they were buying.
I wouldn’t be investing in those kind of penny stocks. However, there are plenty of well-capitalised FTSE listed stocks that have a share price less than £1. It’s these that I’m interested in.
One of the main reasons I’m attracted to such stocks is the growth potential. With some exceptions, most penny stocks are in the FTSE 250 or below. So these are smaller companies than the FTSE 100 heavyweights. In this regard I feel they have higher potential to increase in value. There’s scope to move into the FTSE 100 and join the largest companies in the sector.
One point here is that the smaller the company, usually the higher the volatility. This is because the shares might be less liquid as not as much trading in them goes on during the day. Shares can see larger jumps and falls due to limited volumes passing through.
Investing £100 a month
Given the likely higher volatility, I’d look to invest regularly each month. This way, I can average-in my buying price over time. In my opinion, this strategy works well if the share price is jumping around.
For example, let’s say I invested £100 a month into a penny stock. In month one, the share price was 50p. In month two it dropped to 40p and in month three it shot up to 55p. If I had invested everything in the first month, I’d have an average price of 50p and be up 10%. If I’d invested a bit each month, my average price would be 48.3p, meaning my profit level would be 13.8%.
Given the impact of the pandemic, I’d be looking for penny stocks in areas that could see a strong rebound over the next year or so as we return to some normality.
For example, Topps Tiles currently has a share price of 70p. I think that people will now feel more comfortable splashing out on a new bathroom or kitchen, boosting tile demand, assuming the pandemic doesn’t come back to bite us.
Another penny stock I’d consider is Vertu Motors with a share price of 41p. Again I feel that consumers could open their wallets and look to spend on a new or used car as the economic recovery continues (and again, assuming it doesn’t go into reverse).
Overall, even with the higher volatility associated with penny stocks, I think I can sensibly invest with regular chunks each month.
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jonathansmith1 has no position in any share mentioned. The Motley Fool UK has recommended Vertu Motors. 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.