Should I buy penny stocks or FTSE 100 companies? Both of these investments have advantages and disadvantages.
Penny stocks and smaller businesses can produce larger returns than their blue-chip peers. Smaller companies tend to grow faster than larger ones as they can be more innovative and agile.
However, smaller businesses tend to lack the checks and balances in place at large operations. This means they can be riskier investments. They can also struggle to find funding to keep the lights on during periods of economic stress.
FTSE 100 challenges
FTSE 100 companies are not immune to these pressures, but they may find it easier to raise money in periods of economic uncertainty. They are also less likely to run into terminal issues.
For example, losing just one contract for a smaller business can be the difference between a profitable and unprofitable year. It is unlikely the loss of one or several contracts will significantly impact the growth prospects for a blue-chip stock.
My solution to this problem is to own a diverse portfolio of both penny stocks and FTSE 100 equities. I think this approach will reduce the impact of losses on my portfolio if one of the smaller companies runs into problems. It should also help me overcome some of the issues of investing in blue-chips, namely the lack of growth.
Investing with penny stocks
Two organisations I would be happy to own in my portfolio as part of this strategy are GlaxoSmithKline and Advanced Medical Solutions. The former is one of the largest pharmaceutical companies in the world. The latter is not a penny stock, but it is a small firm in the world of healthcare equities.
Nevertheless, over the past couple of years, the group has expanded rapidly as its innovative wound treatment solutions have picked up customers worldwide. Because the company is relatively small compared to its multi-pound dollar peers, there is always going to be a risk the corporation could start to lose market share to a larger competitor.
That is why I would own the stock alongside Glaxo. The FTSE 100 company’s growth has left a lot to be desired over the past five years, but it has paid a consistent dividend of around 5%. I think this level of income complements Advanced Medical’s growth potential nicely.
Property market exposure
Another example is Natwest Group and Foxton’s. The bank and the estate agent are both exposed to the UK economy, in particular the property market. As a penny stock, Foxton’s has the potential to grow faster, but it lacks diversification.
Natwest’s UK-wide footprint provides diversification and expansion potential. The bank is also well capitalised and has scope for significant dividends.
One risk both businesses may have to deal with is an economic slowdown. In this scenario, both could suffer a decline in profitability.
Still, despite this risk, I would buy the two companies for my FTSE 100 and penny stock portfolio.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has recommended Advanced Medical Solutions and GlaxoSmithKline. 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.