With the Petra Diamonds share price in pennies, should I buy?

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Shares in Petra Diamonds (LSE: PDL) have been moving around lately but currently trade for a bit less than a pound. That is a fall from the highs the price hit in April. But over the past year, the Petra Diamonds share price has grown by 19%.

So, after the recent fall back, is there an opportunity to add the company to my portfolio?

Volatile financials

When I invest in a business, I like one that has a proven model of profitability. That does not mean that it needs to be profitable every year – but massive swings in profitability concern me.

That is one red flag that strikes me immediately about Petra Diamonds. Last year it made a profit of $197m. But the year before that, it lost $223m. The year before that, the loss was even larger, at $258m.

Those are big numbers – and in the wrong colour of ink for my liking.

Partly that reflects the volatile nature of the diamond market. Lately, things have been moving in a positive direction. In its most recent financial year, for example, the company sold 11% fewer carats of diamonds. But revenue from diamond sales still grew 44%. That highlights how the unpredictable nature of diamond pricing means a company can earn more money by selling less than before. But that can go the other way too. With its relatively undiversified business, Petra is heavily exposed to swings in the price of diamonds. Such price swings are outside the company’s control. However, they could affect the Petra Diamonds share price.

Future prospects

This month, the company’s chief executive said that this year’s performance “completes the successful turnaround of Petra”. But one swallow does not a summer make and until very recently the company was still heavily loss-making.

After a like-for-like increase in the rough diamond price of 43% in the year to the end of June, what comes next? The company remains upbeat about the long-term balance between demand and supply for diamonds, which could help support its pricing. But it recognised that “there may be some volatility in the short to medium term”.

I see a risk that, with many countries in recession or heading into one soon, demand for diamonds will fall. Quite a lot of diamond sales are discretionary costly purchases that may be postponed or scaled down in economically tough times. Even if pricing can be maintained – which is never certain – lower sales volumes would likely lead to lower profits.

On the other hand, the company has been focussed on improving efficiency. That could help boost profit margins. But if demand for diamonds falls sharply, I expect it to be bad news for Petra.

The Petra Diamonds share price does not attract me

The Petra Diamonds share price is in pennies. With a market capitalisation of under £200m, the most recent earnings statement makes the price-to-earnings ratio of under one look incredibly cheap. But the shares do not tempt me. I have no intention of buying them for my portfolio.

The company’s performance is almost wholly tied to demand and pricing for a single item, over which it has little if any control. That is not an attractive business model in my opinion. Just because the company swung into profit last year does not change that.

The post With the Petra Diamonds share price in pennies, should I buy? appeared first on The Motley Fool UK.

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Christopher Ruane 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.