Investing in penny stocks in an ISA is a volatile pursuit at the best of times. But in recent years, factors like inflation, high interest rates, and geopolitical tensions have combined to make it even riskier.
Yet the rewards can still be very lucrative. Just ask investors in Warpaint London, whose shares are up 540% in five years. Or Yu Group, which is a gas, electricity, and water provider for small and medium-sized businesses. It’s share have gone 81p in 2019 to 1,630p today — a massive 1,913% gain!
With interest rates set to fall in the coming months, the small-cap sector could get a boost in 2025. Therefore, this might be an opportune time to consider building a mini portfolio of small-caps and penny stocks.
An appropriate allocation
I say “mini” portfolio for a reason. That’s because while there are undoubtedly hidden gems out there, most penny shares by definition have poor prospects. So I wouldn’t make them a large part of my portfolio.
However, assuming my risk tolerance is high, I’d consider a 5% allocation to smaller companies. This would be enough to move the needle in terms of returns if the strategy worked out well, while also minimising the damage to my portfolio if things go pear-shaped.
What stocks would I buy?
I currently have four holdings that were penny stocks — defined as having a market cap below £100m and a share price under 100p — when I first bought them. They make up around 2.3% of my overall portfolio.
| Description | Share price | Market cap | |
|---|---|---|---|
| hVIVO | Clinical trial services | 28p | £194m |
| Windward | Software-as-a-service | 134p | £119m |
| DP Poland (LSE:DPP) | Pizza restaurants | 11p | £105m |
| Creo Medical | Medical devices | 20p | £84m |
Notice there aren’t any pre-revenue miners or oil explorers here. For me, investing in these types of stocks is too much like speculation. Granted, they do have the potential for explosive share price growth, but I’d rather not take the risk. I could lose 100% of my investment, which isn’t my idea of fun.
Each of the companies above have products and services that are generating growing revenues. hVIVO, which designs and runs human challenge trials, is already profitable and has started paying a dividend.
The other three aren’t profitable yet, but I expect two of them (Windward and DP Poland) to be so in the next 2-3 years. If they achieve this, I expect them to do well in my portfolio. If they don’t achieve profitability, then I expect they will do very badly indeed.
Domino’s Pizza
Take DP Poland, for example, whose shares I bought at 10p this year. The company holds the franchise rights to the Domino’s Pizza brand in Poland and Croatia.
In H1, revenue grew 26% year on year to £26.4m, driven higher by rising orders and increasing market share. By 2026, annual revenue is tipped to reach £76.8m, around 72% higher than last year’s figure.
The firm is still loss-making, which is the key risk here. A spike in inflation and cost of goods sold could also derail its path to profitability.
However, analysts anticipate positive earnings in the next couple of years as the company pivots to a capital-light franchise model. Longer term, DP Poland plans to open hundreds more stores across Poland and Croatia (from 111 today).
Foolish takeaway
If I were to build a penny stock portfolio in 2025, I’d exclude firms with no sales. Instead, I’d focus on those showing strong revenue growth and on a clear path to profitability or already profitable.
This post was originally published on Motley Fool
