Spending £1,000 on a penny stock, then watching that turn into £4,000 in just half a year, sounds like the stuff of investor dreams.
But that is exactly what I could have done in real life, had I only bought into the right penny share back in October. Despite its meteoric price rise in the months since, that share continues to sell for pennies today. Ought I to do what directors have been doing this week and buy it for my portfolio now?
Price turnaround
The share in question is educational tech provider RM (LSE: RM). Although it is down slightly over the past few days, at one point late in April the RM share price had quadrupled since October.
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Still, I can buy this penny stock for just 37% of what I would have paid five years ago, when the share price was over two pounds.
That sort of dramatic price action rarely happens for no reason. RM is no exception.
After several years of declining profitability, last year it swung to a £16m loss and cancelled its dividend. RM faced a number of business challenges, such as a new IT platform implementation turning out to be slower and costlier than expected. That led to a profit warning last autumn that saw the penny stock tumble.
It also relaxed its bank covenants. That can be a sign of a company operating close to the limits of its previous financial expectations, although banks agreeing to such a relaxation can be a positive sign that they continue to see potential in a business.
Net debt more than doubled between the end of 2021 and last year’s interim results.
A missed bargain
Looking back with the benefit of hindsight, I think RM shares in October would have offered my portfolio a bargain. The business was struggling with an important IT implementation but underlying performance remained strong. The share price fall at that point now looks quite overdone.
But given the strong share performance in the past six months, does this penny stock still offer my portfolio value?
Here I am less confident.
The price-to-earnings ratio of just three or four based on pre-pandemic earnings looks compelling. But the past three years have seen far smaller earnings – or a loss – for the firm. Given that IT is core to RM’s business, the delays to the new platform remain a significant risk to profits in my view.
As the chief executive remarked in last week’s results announcement, “there is much to be done to rebuild value for our stakeholders”.
Recent director buying
Set against that, the chairman and five other directors have dipped into their own pockets to buy the penny stock over the past week alone.
That level of board enthusiasm suggests that the people who run the company think the shares are undervalued even after their recent meteoric rise.
But while they are close to the business, I can only go on the most recently published financial reports. Based on them, I do not see this penny stock as an obvious bargain for my portfolio today.
The company’s recent history of weakening profitability concerns me, while budgetary pressures on the company’s school customers are a risk to revenues. For now, I have no plans to invest.
