Recently, I have been looking for cheap penny shares to add to my portfolio that could produce substantial returns. I think the three companies listed below meet the criteria I am looking for, and would acquire all three considering their potential.
Penny shares for growth
The first company on my list is N Brown (LSE: BWNG). I am wary of investing in the retail sector in general because of the ongoing shift from physical to online retailing.
However, N Brown is now a pureplay digital retailer. I think this gives the company an edge in the competitive retail landscape, although it is not immune from sector competition.
After a rough 2020 and 2021, where sales declined more than 20%, analysts expect growth to return in 2022. Based on current growth projections, the stock is selling at a forward price-to-earnings (P/E) multiple of around 6. That looks cheap compared to the industry average, which is around 12 to 14.
Based on this valuation and the company’s competitive advantage, I think the stock could increase in value over the next few years as growth returns.
Unfashionable industry
Unfashionable sectors tend to be good places to hunt for discount shares. Smiths News (LSE: SNWS) is a great example.
The newspaper and magazine distributor operates in a slow and steady unfashionable industry, which is nowhere near as exciting as some of the hot sectors of the market like technology.
Still, the company does provide an essential service, and after the disruption of the pandemic, it looks cheap. While revenues are expected to decline over the next two years, efficiency initiatives will help it improve bottom-line growth, according to City analysts.
Based on these projections, the stock is selling at a forward P/E multiple of just 4. This makes the company one of the cheapest penny shares on the market.
That said, I am under no illusion newspaper distribution is a declining business. Profit margins are also razor-thin, leaving no room for error.
These are the biggest challenges the organisation faces. Nevertheless, I do not think it will take much for the market to reevaluate the stock and its potential. This could lead to a substantial increase in the company’s share price.
Construction sector growth
The final company I am highlighting is tool and equipment hire business HSS (LSE: HSS). There are two reasons why I like this business right now. First, the construction sector in the UK is booming, which could provide a solid tailwind to support the group’s growth in the years ahead.
At the same time, the company is starting to reap the benefits of a multi-year transformation plan. City analysts believe the firm could report a net profit of £4m for the 2021 financial year, thanks to these twin tail winds. To put this into perspective, over the past six years, the corporation has lost a total of £130m.
Based on analysts projections, the shares are trading at a 2022 P/E of 6.2.
The most significant danger here is the risk the company could go back to its old ways. If costs rise significantly and the construction market starts to stagnate, losses could return.
Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK 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.
