Making Cents in Penny Stocks

Editor's note: A previous version of this article contained comments from a CAPS participant that we were unable to substantiate. We have removed those comments from the article. 

"That's what storms were made for
And you shouldn't be afraid for
Every time it rains it rains
Pennies from heaven."
-- Bing Crosby, Pennies From Heaven

If it did rain pennies from heaven, a few good thundershowers would sure do our bank accounts some good. But as Fools, we know that penny stocks are dangerous to our financial situation. Because the world of penny stocks is full of shysters peddling their manipulation and deceit, it's often hard for investors to separate the few good companies that reside there from what's best ignored.

Although many people like investing in penny stocks, believing that such stocks have a better chance of increasing many times in value, there's nothing that says a $20 stock can't double, triple, or quadruple in value just as easily as a cheaper one could. Considering that a cheap stock may be cheap for a very good reason, there's ample evidence to suggest that the higher-priced stock may actually have a better chance of going up than the cheap one does.

Still, many investors dabble at the low end of the stock-price spectrum. At Motley Fool CAPS, we note the investors who, more than half the time, rate stocks trading in the single digits, and we give them a saucy name -- "Pennies." Believe it or not, you'll find some of the best CAPS All-Star investors among them.

Pinching pennies
This week, we'll take a look at some of the low-priced investments that these All-Stars have identified as possibly the best and worst stocks. If the best investors who regularly scan this end of the market have singled out these companies, we might want to turn our umbrellas upside-down.

Here's a list of low-priced stocks that the All-Stars say will outperform the market:

Company	Price	CAPS Rating (out of 5)	Player	Player Rating
Level 3 Communications (Nasdaq: LVLT)	$4.84	****	ETLA	99.15
Golden Star Resources (AMEX: GSS)	$4.28	*****	ltmm	98.62
American Software (Nasdaq: AMSWA)	$9.11	*****	Iraken	99.24

And here's a list of those they think will underperform:

Company	Price	CAPS Rating	Player	Player Rating
TOUSA (NYSE: TOA)	$1.22	*	zygnoda	99.68
Hoku Scientific (Nasdaq: HOKU)	$9.85	*	ETLA	99.15
Home Solutions of America (Nasdaq: HSOA)	$3.47	*	ltmm	98.62

As we delve into low-priced "pennies," we find that the All-Stars we highlight here are not the only ones who like -- or dislike -- the prospects the companies face. Home Solutions, for example, has drawn passionate partisans to both sides.

On the bearish side, it has drawn top-rated All-Star TheGarcipian, who bluntly writes that he thinks that, based on his research, the company is a scam.

I discovered Home Solutions seems to be a house of cards: crooked management with ties to convicted felons and consumer fraud; a H-U-G-E 39.6% short float (I'd bet I couldn't even find anyone to loan me their shares so I could short it!); incredible share dilution; very possible fraud connections in setting up shadow businesses to boost their own image/income; and it's been a 1-Star CAPS stock for the last 6 months (things ain't getting better, despite their "press release")...This one's gonna [be] washed away by the hurricane surge that will certainly engulf them when their scandalous ways are finally known to the general public and its investors. Big thumbs down!

For the bulls, CAPS player tridenttn thinks there are vested interests determined to see Home Solutions sink.

HSOA is a solid, growth story that has been unfairly beaten down by short selling ... The company's revenues grow sequentially in the high double digits, and their business model is not only diversified across 5 levels, but has solid potential for double and triple digit gains.

Make some change
There you have it -- some of the top CAPS investors giving their reasons why these "penny stocks" may or may not be a good investment. What do you think? Should we break out the change jar to buy them, or ignore them like discarded pennies on the street?  Put in your two cents for free on Motley Fool CAPS.