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A penny stock I’d add to my long-term portfolio

UK money in a Jar on a background
UK money in a Jar on a background

When building a portfolio, I like looking for good quality companies that I can buy and forget. The goal of these holdings is to achieve a steady level of growth for many years without needing to monitor the stock constantly.

I used to think this goal wouldn’t be achievable with a penny stock, as these are considered more risky, unstable, and just for short-term trading. I instead used to focus on larger companies, believing their size would make them more stable and safe.

However, the reality of penny stocks is very different. There are a number of shares trading at less than £1 on the FTSE 100 and FTSE 350. This means that I can find good longer-term holdings that are reasonably sized and traded on the main exchange while also technically being a penny stock.

For my long-term investment portfolio, I’m looking for companies that can grow consistently for many years, while paying a dividend. I don’t want a company that can boost its earnings dramatically in one year and then struggle in subsequent years. I want high-quality companies that give me enough confidence to leave them alone. These should prevent fear that my investment is at significant risk.

A new opportunity

A prime example of what I am after is Coats Group (LSE: COA). The company is a manufacturer of thread and yarn for industrial and consumer use. It currently has a market capitalisation of £1bn, much larger than I would previously associated with a penny stock, and is a constituent of the FTSE 350 index.

The company has experienced somewhat varied share price performance over the years, falling almost 10% in 2020, followed by a slight recovery in 2021. However, it is now down 6.8% in 2022 and has a price-to-earnings (P/E) ratio of just over 10. The P/E ratio is forecast to fall to just 9.2 in 2023.

Solid fundamentals

Despite this, the company has a set of solid underlying fundamentals. It has reasonable profit margins, significant earnings efficiency on capital, and above-average forecasts. Analysts forecast turnover to grow by 9.4% next year, considerably above its three-year average of 2.1%.

The company is also currently paying a dividend yield of 2.9%, which is expected to hit 3.1% next year. Furthermore, this dividend has been paid consistently for the last six years and has grown for the previous two. It also has a dividend cover of 3.2, indicating that the current yield can be comfortably covered by earnings per share (EPS). This cover is forecast to reach 3.5 times next year.

However, it’s important to note a few underlying issues with the company, such as the debt level. This is over 30% of market capitalisation and is above the three-year average of 25.1%. Additionally, free cash flow conversion is lower than I typically like, at under 60% of EPS.

Nonetheless, this is a prime example of a penny stock that I think can make a great long-term investment opportunity for my portfolio. I plan to buy Coats Group when I have the necessary funds.

The post A penny stock I’d add to my long-term portfolio appeared first on The Motley Fool UK.

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Gabriel McKeown has no position in any of the shares mentioned. The Motley Fool UK has recommended Coats Group. 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.

Motley Fool UK 2022