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Why are penny stocks being scooped up by insiders right now?
I find that many penny stocks are at their cheapest since the 2008 Financial Crisis.
For instance, Argent Industrial shares traded at R9 each in 2010 – while the company made around 55cps earnings.
Or take Rolfes for instance, in September 2011 the company announced a jump in earnings to 31.2cps – with a share price of 250c.
The company announced interim earnings of 19.46cps in March – with full year earnings likely to hit around 40cps. But its share price is actually 237c…
Simply put investors are getting MUCH more earnings power from companies – for a smaller investment.
In fact – the situation has become so attractive that directors are scooping up millions in these companies. And in some cases companies are using million in cash earnings to buy back shares because their shares are so ridiculously cheap…
But what do share buybacks mean for investors?
The basics of share buybacks
By definition, share buybacks allows companies to reinvest in themselves by reducing the number of outstanding shares on the market.
Typically, buybacks are carried out on the open market, similar to how investors purchase stocks. While there has been a clear shift in wealth distribution of dividends to stock repurchasing, this doesn’t mean a company cannot pursue both. Many companies do share buybacks AND pay dividends.
The thinking however is that if a share price is low, buybacks are a better return to shareholders than dividends.
Here's how it effectively works:
Company A has 100,000 shares in issue.
Company A makes R10 million profit this year.
Earnings per share is R100.
So if the share price is R500 and the company takes R5 million to repurchase shares it can repurchase 10,000 shares.
That means now it has 90,000 shares in issue, but annual profit still remains R10 million.
So earnings per share is now R111.11 – 11% earnings growth.
So the company’s share price is expected to rise – or at the very least it’s ability to pay bigger dividends in the coming year increases.
The other benefit here is dividends are taxed immediately – but an increase in the share price is only taxed once you sell your shares – and you can use your capital gains tax exemption to limit the tax paid.
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The bottom line – shares are at SUPER attractive valuations right now
Simply put many penny shares are dirt cheap.
These companies are either buying back their own shares or directors are piling into them.
And as more share buybacks are done – so share prices become even more attractive…
Eventually something’s got to give and investors will start piling back into the small cap sector.
And then these uber cheap shares will be the ones to fly!
Here’s to unleashing real value,
Francois Joubert,
Editor, Red Hot Penny Shares
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