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Investing in penny stocks can be exciting and very rewarding. The small size of these companies can mean they go unnoticed by investors in big cities. In my experience, sometimes it’s possible to get a hidden bargain that just wouldn’t exist in the FTSE 100 or FTSE 250.
Of course, the flip side of this also applies. Smaller businesses may be less established and more likely to experience financial difficulties.
The two companies I’m looking at today are relatively small, but in my opinion they are profitable and have strong financials. I think both could be good investments in the next three to five years. This is why.
Value price, quality business?
car sales group Vertu Engines (LSE: VTU) has 188 franchised dealerships across the UK, with a focus on premium brands such as BMW, Jaguar Land Rover and MINI.
It is true that the UK car market is expected to slow down this year. But recent trading has been strong and I think Vertu’s forecast P/E ratio of six already reflects a cautious outlook.
Another attraction for me is that the group owns outright ownership of many of its dealerships. This means that there is a lot of asset support for the share price. If the business is in trouble, freehold can usually be used to raise cash.
Vertu’s most recent accounts showed tangible assets of 71 pence per share, compared with a share price of 56 pence. The recent acquisition of the Helston Garages dealership group means these numbers will have changed slightly, but I think the bottom line should remain very strong.
What can go wrong? This business has a decent market share and I think it is well run. But if the UK suffers a severe recession, earnings could fall much more than expected. If that were to happen, the stock could fall further and the dividend could be reduced.
However, as things stand today, I think Vertu is decent value. I think this penny stock could do well in an economic recovery.
delivering good news
My second choice is the distribution group. Blacksmiths News (LSE: SNWS). This company has an overnight delivery network that is used to deliver newspapers and magazines to retailers.
There is an obvious risk with this business: the circulation of print newspapers and magazines is steadily falling. However, according to Smiths, the decline is fairly steady and predictable. Until now, the company has been able to adjust its network each year to remain profitable with lower volumes.
The long-term uncertainty surrounding this business is reflected in a super low valuation. Smiths News is currently trading on just five times forecast earnings, with a well-covered dividend yield of 7%.
The risk is that, at some point, someone probably needs to find a new use for the group’s nightly network. Otherwise, it could become unsustainable.
Despite this, the next few years look pretty secure. Smiths has already secured long-term contracts for 46% of its newspaper and magazine revenue. A recent deal with Telegraph Media Group runs through 2029, for example.
If the dividend holds, then the 7% yield would provide a 35% return in five years, even if the stock doesn’t move.
I wouldn’t bet the farm for this value, but I think it probably offers a good opportunity at current levels.