Making Cents in Penny Stocks

The occasional shower of pennies from heaven might do our bank accounts some good, but we Fools can't say the same for penny stocks. Because the world of penny stocks is often full of manipulation and deceit, investors can have a hard time separating its few good offerings from the multitude best ignored. Though some investors think cheaper stocks have a greater chance to appreciate, those stocks may be cheap for a reason. Indeed, a $20 stock may have even better chances of gaining value than a $0.20 one does.

Still, many investors dabble at the low end of the stock-price spectrum. At Motley Fool CAPS, we award the "Pennies" title to investors who more than half the time rate stocks trading in the single digits. Believe it or not, you'll find some of the best CAPS All-Stars among those players.

Pinching pennies
This week, we'll look at some of the low-priced investments that these All-Stars have praised. If the best investors regularly scanning this end of the market have singled out these companies, we might want to turn our umbrellas upside-down.

Here's the latest list of low-priced stocks with All-Star support:

As we delve into the low-priced "pennies," we find that the CAPS community likes most of these companies -- at least the ones that carry a CAPS rating of three stars or better. So let's drill down a bit further into one of them.

A leap of faith on Alesco?
Alesco Financial is a real estate investment trust that has been buffeted by a bevy of risky debt instruments, such as collateralized debt obligations and mortgage-backed securities. It's been hammered as a result of the seizure in the credit markets. It's written down assets and minimized its recourse debt. Management says none of its debt is subject to margin calls and says it is taking the necessary steps to preserve capital while also limiting loan losses.

Short sellers still aren't sold on Alesco's viability, though: More than one-fifth of the outstanding shares are sold short. And since REITs have to pay most of their earnings as dividends -- Alesco's yield is in excess of 25% -- there's always the possibility the stock's rich dividend could fall dramatically if the company's profitability declines.

Top-rated CAPS All-Star pytheian thinks the chances that will happen have been minimized by the actions management has taken to shore up its finances:

Only two questions

1. Can they keep it up (obviously assumes no bankruptcy)?
2. Can they maintain their REIT status (otherwise potential for double taxation)?

[Management] represents that they've:

1. Taken all their medicine (written down assets to market value)
2. Freed up cash
3. Gotten rid of recourse liabilities (which drive margin calls)

If true, this is a moonshot. Biggest red flag is that they're not buying their equity [at] these prices, but caution is warranted since [there] is still a pall on derivatives.

Management authorized a $50 million share buyback in August, and after an initial $2 million purchase, it hasn't bought back any more shares over the past eight months. Of course, with the cash situation being what it was, preserving its capital it probably wasn't a bad step to take.

Make some change
What do you think? Should we fill up the change jar with these penny stocks, or should we ignore 'em like a discarded coin on the street? Consult our free Motley Fool CAPS investor-intelligence community, where your two cents count as much as anyone else's.