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Say “penny stock” and the first thing that comes to mind for some investors may be a loss-making company with no revenue but rights to mine in some far-flung locale.
In reality, penny stocks come in all shapes.
Take Logistics Development Group (LSE: LDG) for example.
It is solidly profitable. In fact, last year’s net profit of £19m means the company’s current price-to-earnings ratio is just three.
The company owns stakes in a number of well-established businesses, such as Finsbury Food Group and Alliance Pharma.
So, could this be the deep bargain its P/E ratio may seem to suggest?
A Buffett-like approach
For starters, it is worth noting that the earnings have moved around dramatically in recent years. Last year’s earnings are not necessarily at all indicative of what may happen in future.
But looking at another valuation metric, the penny stock also seems very cheap.
Its last update on its net asset value, at the end of September, stood at 26.7p per share. That may have moved up or down since then. Hopefully it has gone up given management’s focus on value creation: that September net asset value was already 9% higher than the previous one just six months earlier.
But, using the September figure, that net asset value is close to double the current Logistics Development Group share price.
Why is there such a big discount?
One reason is the City seems lukewarm about the firm’s strategy of owning stakes in a small number of private companies then hanging onto them for years without paying dividends.
But that reminds me of the approach of some very successful wealth creators, such as Warren Buffett.
No obvious trigger for price rerating
However, I see this as a stock where Buffett-like patience is not only desirable but possibly essential. I reckon Logistics Development Group is creating value over the long term but is in no hurry to sell its stakes, or pay dividends. That might explain why the share price is drifting.
Over the past year, the company has used up much of a chunky cash pile. Part went to investing in a new national logistics platform. I see that as a promising business opportunity.
Some of the cash also funded a tender offer in which the firm bought back some of its own shares well above their market price when the offer was announced. I sold my shares at that time and made a profit.
Since then I have bought more of this penny stock for my portfolio.
But while the business has clear value – as shown by the net asset value – that value is basically locked up in a portfolio of investments for now. That could mean that there is no clear reason to expect the share price valuation gap to close in the short term.
In it for the long haul
I am a long-term investor, though, and from a long-term perspective I think this penny stock looks badly undervalued.
There are risks due to the concentration of investment in just a few private companies. One bad choice could significantly hurt the firm’s performance.
But I think time will help bring the share price closer to what it is actually worth. I therefore plan to hold onto this share for the foreseeable future.
