A penny stock is generally a small company with a share price under 100p. Over the years, I’ve found that hunting among these small-cap stocks can be a good way to find overlooked gems.
I think that’s what I’ve done here. The company I’m going to talk about today is highly profitable, growing steadily, and offers a 4% dividend yield. I reckon the shares are probably too cheap. Here’s why.
A successful growth story
The company in question is mining services group Capital (LSE: CAPD). This firm was founded in 2005 as a drilling contractor operating in the East African gold mining sector.
Capital has since expanded to offer a broader range of contract mining services across Africa and the Middle East. The business also has a valuable laboratory business, MSALABS, which tests mining samples for mineral content — an essential service for mining operators.
Profits have soared in recent years, rising from $5m in 2017 to $70m last year. This rate of growth has been helped by the recovery in the price of gold, which rose from around $1,200/oz to $1,800/oz over the same period.
I don’t expect Capital’s profits to continue growing at this rate. But unless the gold mining sector suffers another serious slump, I think this business should be able to continue expanding.
Owner management
When I’m investing in penny stocks, I try and find companies where senior management have big shareholdings. In my experience, owner-managers often have a long-term focus and a cautious approach to debt, which I like.
Capital seems to satisfy both of these requirements. Founder Brian Rudd remains a director and still has a 6% shareholding. Executive chairman Jamie Boyton, who joined in 2007, owns 12% of the business.
Debt levels are low and look very comfortable to me. I’m confident Capital could survive a downturn without serious financial problems, especially as a lot of its revenue is tied to long-term contracts.
What could go wrong?
All investments carry some risk. When I invest in a new business, I always try to imagine what could go wrong. If I can’t think of any potential problems, that probably means I haven’t understood the business properly.
I’m pretty happy that Capital is well managed and has a sensible growth plan. My main concern is over the cyclical nature of the gold business and an unusual quirk in Capital’s business model.
In addition to providing fee-based services, Capital also invests directly in some of its customers. These investments were valued at $47m at the end of June, so they’re quite significant.
I’m sure that Capital is a very well-informed investor. But mining is a risky business. If the market heads south, these shares could end up losing much of their value.
I’d buy this penny stock
Capital isn’t without risk, but I rate the company’s management highly. The firm’s shares are currently trading below their book value and on just five times forecast earnings. There’s also the 4% dividend yield I mentioned earlier. That should provide me with an attractive cash income while I hold.
On balance, I think Capital shares are too cheap. This penny stock is on my list as a potential buy when I next have cash available in my portfolio.
