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Penny stocks are enormously popular among investors with a high tolerance for risk and volatility. That shouldn’t be surprising, given all it takes is for one of these tiny companies to erupt into success to unlock skyrocketing returns. And that’s exactly what’s happened with Filtronic (LSE:FTC) over the last two years.
In March 2023, shares of this avionics enterprise were trading close to 12p with a market cap of around £25m. Today, they’re at 108p with a £235m market cap. That’s an 800% return in the space of two years. And to demonstrate just how explosive this is, a £10,000 investment two years ago would now be worth around £90,000!
Considering the UK stock market only averages around 6% to 8% returns each year, this level of growth is pretty phenomenal. But with so much growth already under its belt, is it too late to hop on the gravy train?
Making waves
The primary catalyst behind Filtronic’s current success is its newly formed relationship with Elon Musk’s SpaceX. The company has secured a collection of multi-million-dollar contracts that sent its top line flying, with half-year revenues surging from £8.5m to £25.6m.
With SpaceX planning on drastically expanding its mega-constellation of satellites, demand for Filtronic’s electronic components isn’t likely to subside any time soon. And with management using the proceeds of these new contracts to expand its production capacity in the future, Filtronic may soon find new customers from the aerospace industry knocking on its door.
Analyst forecasts currently predict sales in its 2025 fiscal year (ending in May) will come in just over the £50m threshold, with earnings rising to £4.8m. Assuming these projections are accurate, that’s a notable increase from the £16m and £0.24m of sales and profits reported in its 2023 fiscal year. And it’s easy to understand why there’s a lot of excitement surrounding this enterprise right now.
Too late to buy?
Even if Filtronic meets analyst expectations this year, today’s share price puts the forward price-to-sales ratio at 4.7 and the forward price-to-earnings ratio at 49. These aren’t the sort of figures that can typically be used to describe a cheap stock. And it’s clear that investors are baking in a lot of future long-term growth into the current valuation.
Should Filtronic fail to keep up with investor expectations, the small-cap enterprise could begin behaving like a penny stock again. That would mean enormous share price volatility. So, what could go wrong?
Beyond the usual challenges of supply chain disruptions that many electronic firms have to navigate, Filtronic’s revenue and earnings are currently almost entirely dependent on SpaceX. And this customer concentration risk is problematic.
Given Filtronic’s current dependence on SpaceX, the firm likely doesn’t hold much pricing power when negotiating contracts. And if Filtronic starts falling behind on its existing obligations, the chances of signing future deals could be negatively impacted.
Combining this with the stock’s rich valuation, I’m not rushing to add any Filtronic shares to my portfolio today. The risk is simply too high for my tastes.
This story originally appeared on Motley Fool
