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The dream of buying a penny stock to see it go up in value may be appealing – but in reality many are taking a big step in the wrong direction.
The best performing penny stock over the past five years is the mining explorer Kodal Minerals (LSE: KOD). Meanwhile, the share has increased 540%.
It still sells for less than a penny (less than a farthing in the old money, in fact!) but recent performance has been disappointing. This year the price has dropped by 11%.
Kodal Minerals’ share price is now about 64% lower than its peak in April last year (coincidentally, the same month I wrote that I would not invest in the miner).
A rollercoaster ride
That kind of volatility underscores the point that, in general, investing in penny stocks is not for the faint of heart. So what was going on – and could the low price give me an opportunity to add Kodal to my portfolio?
As is often the case with penny stocks, Kodal is basically interested in some potentially lucrative mining prospects. But whether that ends up being the case depends on factors such as production performance, political risk (Kodal’s flagship project is in west Africa) and market prices for the minerals it intends to mine (such as lithium in the prospect area).
The temporarily rising lithium price, promising results from key drilling sites, and a partnership with a major Chinese mining company all help explain why Kodal’s price has performed so well over the past five years.
Maybe there are still more opportunities
But I think those things are now factored into the share price, especially the Chinese deal which has helped boost Kodal’s appeal as it involves a significant cash injection.
I still see a lot to like about the Kodal investment case. The largest lithium project in west Africa is nearing completion and production is expected to start in the first quarter of next year. From the second quarter of next year, the company is planning a strong free cash flow (although for now that remains a guess – we’ll see what happens in practice).
At the end of March, Kodal had a balance of £16m. That’s equivalent to about a quarter of its current market capitalization and helps it fund ongoing operations before it enters free cash flow generation.
Tempting, but not for me
All this is known in the market. But I still think that, if production really starts next quarter and Kodal generates strong free cash flow over the next seven months or so, as it predicts, that might encourage some investors to reconsider its investment case.
If things go well – for example production meets targets and lithium prices are reasonable – I could see a reason for the price to rise.
But the last several years have seen the price of lithium drop significantly (although it is still above where it stood five years ago). Kodal is very dependent on one project. Some investors may be comfortable with that level of risk but I am not, so I would not buy this penny stock.
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