Penny stocks — companies with share prices below £1 and a market caps below £100m — are high-risk, potentially-high-reward investments. They’re often volatile and speculative, but they can offer the chance of significant returns. That’s why I’m eyeing up some for my portfolio.
One company on my radar is full-service law firm Gateley Holdings (LSE:GTLY), which started life as a penny stock when it debuted on the London Stock Exchange nine years ago.
The Gateley share price isn’t trading in pennies currently — it’s £1.14 today. However, that’s much lower than its late-2021 peak above £2.57.
Here’s why I’m optimistic the shares could bounce back soon.
Industry innovator
Gateley presents a distinctive investment opportunity. Although UK law firms have been able to list on the stock market since 2011, only a handful have done so.
In fact, Gateley was the first to seek external investment with its AIM floatation. The vast majority of firms remain private businesses exclusively in the hands of lawyers.
It’s a lucrative sector, as I know from my days as a former City solicitor.
Choosing to go public isn’t the only way Gateley’s shown itself to be an industry pioneer. The firm’s completed 14 acquisitions over the past decade. Most of these have been non-legal enterprises, including chartered surveyors, property consultants, and tax incentive specialists.
These complementary services have been the main drivers of turnover growth recently and an important source of diversification. They now represent over a quarter of the group’s total revenue.
Many analysts believe this kind of hybrid business model will be increasingly common in the legal industry.
Indeed, the ‘big four’ accounting firms — KPMG, Deloitte, EY, and PwC — are a growing presence in the legal sector, having already become market leaders in consultancy.
I think it’s promising that Gateley’s recognised this trend early. It’s already ahead of many competitors in beefing up its consultancy offering and continued investment is a key priority for the board.
Ultimately, it may only be a matter of time before the firm’s expansion into new growth areas is reflected by a share price reversal.
Uncertainty and opportunity
However, a 15% slump in half-year adjusted operating profit to £8.6m, a drop in fee earner utilisation, and a certain degree of coyness about full-year guidance, have added uncertainty to the investment outlook.
In addition, some investors may have deeper concerns about buying shares in a listed law firm. Partnerships can be difficult to manage at the best of times, let alone when external shareholders are involved.
Nonetheless, I think these risks are amply compensated for by the chunky dividend yield. Pushed up by the share price fall, investors can now bag an 8.3% yield. That’s a very healthy dose of passive income.
Gateley’s valuation looks appealing too. A forward price-to-earnings (P/E) ratio of just 6.8 is well below the five-year average. That indicates to me there’s a chance the shares are now oversold.
The market might have reacted badly to the board’s comment that the full-year performance would be “more difficult than usual to forecast”, but lawyers are often cautious business people. Time will tell whether this was, in fact, prudent expectations management.
Overall, I think this stock’s worth considering before a potential share price recovery.
