Penny stocks carry significant risks but some can provide lucrative returns in the long term. One pick I currently believe is dirt-cheap with plenty of upside for the future is Costain Group (LSE:COST). Here’s why I like it for my portfolio.
Costain is a leading UK-based construction and engineering firm. It looks to apply cutting edge technology to add value to its clients’ projects. Some of the sectors it operates in include rail, aviation, water, and defence.
Penny stocks are those that trade for less than £1. As I write, Costain shares are trading for 47p. At this time last year shares were trading for 17% higher, at 57p. The drop in share price is linked to a pandemic-related hangover, as well as continued pandemic issues, coupled with current macroeconomic issues.
Why I like Costain
The UK government has committed to spending billions on infrastructure projects over the coming years. Despite macroeconomic pressures (more on these later) affecting progress, a firm such as Costain should benefit from this capital outlay. Costain has a diversified business model with operations in different sectors and provides its services to public and private sector clients. Some of the public sector clients include powerhouses such as National Grid and the Ministry of Defence. Costain should be able to leverage its position to benefit from this demand.
Costain has a decent track record of performance despite difficulties caused by the pandemic. I understand reviewing its past performance is not a guarantee of any future performance. I like to review this to gauge investment viability and potential future capabilities. It has been a profitable business with an enticing dividend in the past. 2020 was a loss-making year, however, and dividends were cut because of the pandemic.
More recently, Costain’s half-year report was encouraging, however. It showed profit before tax increased to £9.4m. Revenue increased by 2%. Full-year results are due in March 2022. Analysts are predicting earnings growth of over 20% in 2022, which should help Costain back into the black. I do understand forecasts don’t always come to fruition, however.
At current levels I consider Costain a cheap penny stock. It sports a price-to-earnings ratio of just under 20. It has paid a dividend in the past and if it returns to profitability, this dividend could be reinstated. Dividends aren’t always guaranteed, however. Finally, and perhaps most importantly for me personally, it has an excellent, cash-rich balance sheet. This will help navigate recent stormy waters as well as support growth initiatives moving forward.
Penny stocks have risks too
Costain faces macroeconomic pressures such as rising inflation and rising costs. The cost of raw materials, especially those needed in construction and infrastructure projects, has been soaring. These rising costs can affect margins and profitability. Furthermore, the rise of new Covid-19 variants could have a negative impact on some projects too, like when the pandemic first started.
I look to invest for the long term and on that basis I would add Costain shares to my holdings at current levels. I believe it is primed to benefit from the construction and infrastructure boom and the billions of pounds the UK government has committed to spending in the longer term. A robust balance sheet and a diversified model help me justify my decision.
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Jabran Khan has no position in any of the shares mentioned. 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.