Smaller companies often have the potential to deliver decent returns for investors. A smaller underlying business might grow its earnings faster than larger, more mature outfits. With that in mind, I’d consider buying penny shares such as these for my Stocks and Shares ISA.
Penny shares backed by strong businesses
Structural steelwork company Severfield (LSE: SFR) has a market capitalisation near £234m. The business produces and erects steelwork for commercial, industrial and other buildings. And I reckon it could benefit in the years ahead as the UK invests in its infrastructure.
The company has a strong balance sheet and the outlook is positive. City analysts have pencilled in an 18% uplift in earnings for the trading year to March 2022. And with the share price near 76p, the forward-looking earnings multiple is just below 11. Shareholders may also benefit from an anticipated dividend yielding 4% next year. I reckon the valuation looks fair considering the positive outlook.
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However, despite the positives, capital growth from an investment in the shares now is not guaranteed. Perhaps the biggest risk is the cyclical nature of operations. If the general economy sees another downturn while I’m holding the shares, I could find my investment falling in value. Cyclical companies such as Severfield are known for their volatile share prices, earnings and shareholder dividends.
Cyclicality can also lead to valuation compression. We’ve seen that scenario play out with the London-listed banks over the past few years prior to last year’s market crash. It’s possible for the Severfield business to progress while leaving the stock languishing because of a reducing valuation. Nevertheless, I’m tempted to embrace the risks and buy some of the shares now.
Operations abroad
Steppe Cement (LSE: STCM) produces construction cement in Kazakhstan. The company’s market capitalisation is around £79m. The balance sheet is strong and City analysts expect a 33% rebound in earnings in 2021. The outcome will build on a record of rising earnings stretching back at least five years and only interrupted by the pandemic.
The business has been trading well. In 2020, cement market consumption in Kazakhstan increased by 6% compared to 2019. And Steppe Cement’s local market share was just over 15% at 9.4m tonnes. On top of that, there’s a small export operation that increased by 30% to 202,000 tonnes in 2020.
With the share price near 36p, the forward-looking earnings multiple is 12.5 for 2021. And the anticipated dividend yield is 8%. The valuation looks fair to me given the risks involved with holding the shares. For example, Steppe Cement shareholders face all of the same cyclical risks faced by those holding Severfield stock. On top of that, UK shareholders may feel uncomfortable holding a stock backed by operations in a remote country like Kazakhstan. However, I’m tempted by the stock today.
