Making Cents in Penny Stocks

The occasional shower of pennies from heaven might do our bank accounts some good. Alas, Fools can't say the same for penny stocks. They're often subject to manipulation and deceit, making it harder for investors to separate the few good offerings from the multitude best ignored.

Still, many investors enjoy dabbling at the low end of the stock-price spectrum. At Motley Fool CAPS, a "penny stock" is any stock trading under $10, and you'll find some of the best CAPS All-Stars regularly seeking out winning investments there. We identify them with a penny icon.

Pinching pennies
This week, we'll look at two low-priced investments the CAPS community has singled out as those with the best chances of success by bestowing four- and five-star ratings on them. We just might want to turn our umbrellas upside-down to catch them!

Company

Recent Price

CAPS Rating (out of 5)

1-Year Return

Est.
5-Yr. EPS Growth

Return on Capital

Heckmann (NYSE: HEK  ) $5.68 **** 14% 28% 0.2%
Tellabs (Nasdaq: TLAB  ) $4.19 **** (37%) 8% (2.6%)

Source: S&P Capital IQ, Yahoo! Finance.

The above three companies may be low-priced, but that isn't necessarily enough to suggest they'll have an easier time recording big gains. Low-priced stocks are often priced low for a reason. We have to check to see what their catalysts for growth might be before diving in to the shallow end of the stock pool.

These stocks are shakin'!
Opponents of hydraulic fracking, the process of pumping sand, water, and chemicals into the ground to fracture the rock formations and allow greater accessibility to gas and oil reserves trapped beneath, have painted a frightening picture of a looming environmental disaster of groundwater contamination and an oil industry willing to sacrifice our health for profits. Contaminated aquifers can be the only outcome, some say, and even earthquakes are now being blamed on fracking.

Yet water supplier to the oil industry Heckmann says the tall tales are largely a fiction. As it notes, fracking occurs 10,000 feet below the surface -- and water seeps down, not up. The probability of polluted water supplies is minimal.

With some 8,000 gallons of water per well needed to assist the fracking procedure, Heckmann definitely has a dog in the race, but this also makes it an attractive investment. With Cameron International said to own half the market and Siemens and Veolia (NYSE: VE  ) each possessing a significant stake as well, Heckmann won't easily make a crack in the industry. But that leads other analysts to suspect it will become an attractive takeover candidate on its own.

After nearly 300 CAPS members weighed in, 97% of them suggest Heckmann will go on to outperform the broad market indexes. Let us know in the comments section below or on the Heckmann CAPS page if you agree, then add it to My Watchlist to see if its future is as fractured as critics contend.

Disconnecting from the network
It's true: International business is booming for Tellabs, as revenues from the geographic segment surpassed 50% for the first time last quarter. But it's equally true to say that may have been more the result of its North American business's considerable slowdown. Had AT&T (NYSE: T  ) and Verizon (NYSE: VZ  ) continued their capex spending spree, the crossover might have been postponed for some time yet, but the spending freeze that's chilled the optical networking segment is hitting other equipment manufacturers as well.

Ma Bell and Verizon account for a third of Tellabs' revenues, so any cutback by either (or both!) is going to have an outsized impact. Analysts were exceptionally disappointed at the guidance it gave for the fourth quarter, which it will report next week. It has been forced to cut costs to the bone, and even Cisco decided its best course of action was to focus its energy again on the business it knows best. In short, networking-sector winners will continue to be few and far between.

The freeze-out in telecom spending is likely to expand internationally, too, because foreign economies are slipping back into recession. It could make for a challenging period for Tellabs, but the CAPS community remains supportive, with 95% of the All-Stars rating the sector specialist to outperform the S&P 500.

Tell us on the Tellabs CAPS page if you see analysts having their signals crossed, then put its stock on My Watchlist to see if it can dial up new growth.

Make some change
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Fool contributor Rich Duprey owns shares of Cisco Systems, but he holds no other position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Cisco Systems and Heckmann. Motley Fool newsletter services have recommended buying shares of Cisco Systems and Veolia Environnement. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 24, 2012, at 4:23 PM, Teacherman1 wrote:

    Rich, I am confused.

    Just below your chart you say "The above three companies may be low-priced", but you have only two in your chart.

    Did you delete one from your chart, or am I overlooking something?

    BTW, I love "penny stocks", I just hope they don't stay penny stocks for the longer term.

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