Making Cents in Penny Stocks

Low-priced stocks are often low-priced for a reason: They have significant problems to overcome. Yet for those that have fixed their problems, they may be ready to take off to the next level.

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. 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

Estimated
5-Year EPS Growth

Return on Capital

SandRidge Energy (NYSE: SD  ) $7.55 **** (41%) 218% 5.5%
Zalicus (Nasdaq: ZLCS  ) $1.05 **** (54%) NA (41.4%)

Source: S&P Capital IQ, Yahoo! Finance; NA = not available.

These two 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 low-priced for a reason. We have to check and see what their catalysts for growth might be before diving in to the shallow end of the stock pool.

What goes around, comes around
High natural-gas inventories following a warm winter and increased production from onshore shale plays have kept the pressure on spot prices. Low prices for natural gas seems to be the norm for the foreseeable future.

SandRidge Energy is at least one of those attempting to correct the situation, cutting back on its own capex spending and switching to natural-gas liquids, which command much higher prices on the market. Both it and Chesapeake Energy are both moving inexorably to oil and liquids as the fundamentals of the dry-gas market are no longer there.

The two are also the most active in rolling out royalty trust IPOs. SandRidge launched the SandRidge Permian Trust and SandRidge Mississippian Trust I (NYSE: SDT  ) , and it has a second Mississippian trust in the wings. Chesapeake recently IPO'd its Chesapeake Granite Wash Trust (Nasdaq: CHKR  ) .

The benefit is that it allows the parent company to generate gobs of cash for its assets without diluting current shareholders with new stock or burdening itself with debt. Given assets with significant reserves, the trusts should produce oil and gas faithfully over their 20-year lifespans.

As CAPS member 4QCAPS notes, the situation creates a "virtuous circle" that will benefit shareholders for years to come.

It seems the SD is going to use the cash flow from the MLP to help fund the drilling that will fuel the dividends and create a virtuous circle. I'm looking forward to the next MLP IPO. In five [years] this could be a 4 bagger.

Tell us on the SandRidge Energy CAPS page or in the comments section below whether you agree there's method to the madness, and then add it to your Watchlist to see whether it can overcome the vicious cycle of overproduction under way in the industry.

Shining a light on growth
While much of the focus on Zalicus has rightly been directed at its pain-management therapy Exalgo because it is the one product the biotech has on the market, investors would do well to look at the broader picture.

On the risk side of the ledger, Exalgo's marketing partner Covidien agreed to team up with generic-drug maker Watson Pharmaceuticals to produce a knock-off of the pain treatment. While that's obviously a key concern, I noted recently that Covidien specifically didn't include the important 32 mg dosage of the drug, which it views as the real key to future sales growth. Zalicus looks like it has its downside protected there.

On the catalyst side is its advanced pipeline candidate Synavive, which is used to treat immuno-inflammatory disorders. Clinical trials have so far moved apace successfully, and results of phase 2b trials are due later this year. I'm expecting positive outcomes at least at this stage. Last is its partnership with Novartis (NYSE: NVS  ) , where it's using its proprietary Chalice software and combination high throughput screening technology to discover novel treatments. Just remember, small biotech stocks can be a risky endeavor, so do your research before jumping in. 

With risks minimized and catalysts aplenty, I made an outperform CAPScall for the biotech, but you can tell me on the Zalicus CAPS page whether you agree with this assessment, and then put its stock on the Fool's free portfolio tracker to see whether it will be able to drive higher still.

Make some change
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Fool contributor Rich Duprey holds no position in any company mentioned. Check out his holdings and a short bio. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy, Covidien, and Novartis. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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