Low Priced Stocks Or Penny Stocks With Value Investing Methodologies – Does it Work?
When it comes to penny stocks, there is always debate on whether to buy or not to buy, whether it is risky or it is not or whether it is pure speculation or intelligent investing. To answer these questions and more, I think that one has to look at the fundamentals of a company. Value is not in the price. Value is to be found in the financial statements published by the company. Value is to be found in a situation where there is a price to value gap.
So if the fundamentals of a company dictate that a company’s securities have a margin of safety, who cares whether it is a penny stock or not? It does not matter in such an instance. On the other hand, if a company’s stock price trades at a value above its intrinsic value, purchasing that security is a complete speculation.
Again, it boils down to the margin of safety that a security has. Without a margin of safety, expected returns will be a negative number. A portfolio of such stocks will lead to disastrous results in a portfolio.
Benjamin Graham’s Idea Of Low Priced Common Stocks
So that settles the debate then. But if I may elaborate with a few examples, I will give you a few reasons to think about making shrewd investments in penny stocks or what Benjamin Graham would have called “low priced common stocks”.
Suppose there are 2 companies, company A and company B. Both companies have $100 million market capitalization, have tangible book values of $200 million and have an after tax profit of $10 million. Now the only difference is that company A has 1 billion shares outstanding and company B has 1 million shares outstanding. The resulting share price is thus $0.10 for company A and $100 for company B.
So both companies are the same fundamentally except that company A has a stock price that seems cheap relative to company B, at a glance that is. Both companies have a price to earning ratio of 10 and a price to tangible book of 0.5. Both companies have the same valuation on a price to book and price to earnings basis. But, company A seems to be cheaper, to the investing public and hence is prone to speculation bidding up its prices. The speculative bidding in prices can be even more exaggerated for stocks with a low float.
So it is easier for company A to go from $0.10 to $0.15 per share than for company B to go from $100 to $150 per share. Technically, both stocks gain 50% but the company with the lower price is the company that appreciates faster. Hence, these low priced penny stocks have what you would call an advantage in the arithmetic sense. This is especially so when the company’s fundamentals are sound and there is indeed a margin of safety in the form of a price-value gap that investors can capitalize on. These stocks typically trade at a low price to its earnings, assets and/or sales revenue. But once again, call me biased but I would not hesitate to buy a net current asset value stock that meets my criteria which is a penny stock. The arithmetic advantage can work wonders.
Source : Google
In 2009, there was a company called Vibropower that traded to a low price of $0.30 per share as you can see from the chart above here. At that time, the company’s net current asset value per share was $0.64 per share. The company was trading at less than 50% of the net current asset value. Not long after as the recession gloom lifted, it traded at $0.90 per share in 2010 which implied a return of 200% in a very short span of time. Baskets of such stocks, with a high chance of survival and a low probability of bankruptcy can really do quite well when economic conditions normalize. You will find many such instances during a recession. On the other hand, if you were to buy into large caps during a recession, you may not have done as well, especially if there were no drastic shocks to the share price. For Vibropower, it once traded at a price of $2 per share before the recession.
Source : Google
In Singapore, we have a telecommunications company Singtel with a market capitalisation of $52 billion as I write this. It is a behemoth compared to Vibropower’s market capitalisation of $10 million. During 2009, it fell to close to $2 before recovering $4 in around 2015, an implied 100% return if one were to purchase at $2 over a period of 6 to 7 years. Not the best comparison here but you can see the stark difference in performance from trough to peak.
This comparison is anecdotal at best but when it comes to investing in stocks with a low price and have low market capitalisations, I have seen one too many instances of such stocks doing well after recessionary conditions abate. So this is one way you can take advantage of penny stocks. Buy baskets of them during a recession or a bear market but always make sure that what you buy has a margin of safety. That is ultimately the name of the game. Always insist on a margin of safety.
But I am sure you can see the point I am making here. It does not matter if a company is a penny stock or not. What matters is that you make your purchases based on sound analysis. Make sure you do your due diligence and you will come out fine. And if you did not already notice, it’s the small cap, low priced common stocks with a margin of safety that have been beaten down in an exaggerated manner that recover extremely fast when economic conditions normalise.
If you are interest to know more, I made about 37% on a company called Sin Ghee Huat, another small cap company with a seemingly low price, which was ignored by the markets when I first saw it. You can find a short snippet of a case study to be published soon. Stay tuned by signing up for our free email newsletter.
Last but not least, may you be blessed with prosperity, health and happiness!
These books which I have written are case study driven and discuss strategies, mindsets and situational approaches to employing the net current asset value strategy.
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