Penny stocks are considered riskier than larger-cap peers, but at the same time can often offer more attractive returns. Filtering for companies with rising share prices over the past year can help reduce some of the risk associated with any potential purchase. Here’s one that illustrates what I’m talking about.
A diversified operator
I’m talking about SDI Group (LSE:SDI). With a market cap of £87m and a share price of 82p, it fits into the penny stock range. The company isn’t a household name, but its business model is easy to understand. The group owns a diversified collection of specialist companies that manufacture laboratory equipment, scientific sensors, and precision instrumentation.
The company makes money in two ways. First, it generates revenue through the sale of its specialist products. These businesses often serve niche applications with strong customer relationships and recurring demand. Second, it aims to profit from its acquisition strategy, basically buying companies in similar sectors to then improve performance through support. The share price should then increase to reflect the higher overall value of the group.
Carrying momentum
One reason the stock has risen 14% over the past year is due to strong results. The latest half-year report showed revenue up 10.1% to £46.4m and adjusted operating profit rising 17.7% to £4.6m. The business reported encouraging contract wins across a range of areas, including nuclear and professional astronomy, which should set the stage for further revenue growth this year.
I think the outlook is also positive due to the snowball impact of acquisitions. During the past full year, SDI acquired InspecVision and then added Severn Thermal Solutions. These deals expand the group’s capabilities and create additional growth opportunities. It also recently got a renewed debt facility from HSBC, meaning that it has the ammunition to target more companies as it sees fit.
The other point that makes me positive going forward is the sectors that SDI operates in, such as healthcare. I see this as a growing area, given the UK’s ageing population. It’s also a defensive sector, so even if the UK economy struggles in the coming year, SDI shouldn’t see demand materially fall.
Pressure to keep performing
It’s true that the strategy of buying companies can also be seen as a risk going forward. Poor deal selection or integration issues could ruin much of the good work already done. It also needs to be careful about taking on more debt, especially with the potential for higher interest rates in the UK this year.
Despite these concerns, I believe the penny stock could continue to rally. Even though it’s higher risk than some other ideas, I think with a small amount of capital it’s a stock that I’m considering, and feel investors could do the same.
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Jon Smith has no positions in the shares mentioned.
