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This penny stock is up over 120%. Should I buy now?

A red Toyota Supra drives away from the camera

Vertu Motors (LSE: VTU) has had a strong 12 months with the stock up 122% as I write. It’s still a penny stock though, as the share price is 65p.

The company is an automotive retailer in the UK, which includes selling used and new vehicles, and offering an after-sales service. There has been high demand in the vehicle market this year, and this elevated volume has benefited Vertu Motors.

Can this continue? And should I buy this penny stock now? Let’s take a look at the investment case.

The bull case

In Vertu Motors’ interim results to 31 August, the company said the volume of vehicle sales was ahead of market trends in all areas when compared to the same period in 2020. This is a bullish sign for the business as it relies heavily on a high volume sales to generate profits.

I see the vehicle market as remaining buoyant for the time being, so there could still be further upside in the share price. Indeed, Vertu Motors recently upgraded its full-year expectations as new vehicle supply to the company was better than expected in October and November. This will help maintain sales volumes, and is a sign that supply chain constraints may be easing.

What’s more, Vertu Motors sold the additional vehicles at enhanced margins, indicating that demand remains high.

Another point to consider is the strength of the balance sheet. In fact, the current market value of the company is less than the tangible asset value, which itself is underpinned by a property portfolio. This offers significant downside protection for a potential investor like myself. One way of looking at this is by the price-to-net-asset-value ratio, which is a cheap 0.8 as I write.

The bear case

As mentioned, Vertu Motors has to sell a high volume of cars to generate its profit. For example, in the last full-year results, the company generated £2.5bn in revenue, but only £32m in operating profit. This is a wafer-thin operating margin of about 1.3%.

Therefore, demand for vehicles in the UK has to remain high for it to make significant profits. Any continued supply chain disruption may reduce the company’s ability to keep the volume of vehicle sales high.

City analysts are also forecasting profit to decline by 58% in its fiscal year 2023 (the 12 months to 28 February 2023), which would be a significant fall. This does suggest that the company has benefited from a purple patch this year from the booming automotive market.

Is this penny stock a buy?

Taking everything into account, I view the investment case favourably here. Vertu Motors has been able to navigate the difficult trading conditions over the pandemic, and its share price has responded accordingly. The margin of safety provided by its robust balance sheet also mitigates some of the risk of investing in this penny stock.

I do have to keep in mind the prospect of reducing profit in the next fiscal year, and the potential for further supply chain disruption. Nevertheless, I’m considering buying this stock for my portfolio.

The post This penny stock is up over 120%. Should I buy now? appeared first on The Motley Fool UK.

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Dan Appleby has no position in any of the shares mentioned. The Motley Fool UK has recommended Vertu Motors. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.