Another Penny Stock From Heaven

Ah, penny stocks. Quite possibly the world's most dangerous investments. Yet also so enticing.

And for good reason. Some of the world's best stock pickers are, at times, penny-stock investors. Peter Lynch, for example, has and still does enjoy the stock market's super-cheap seats. The Royce Low-Priced Stock fund crushes the market by betting on stocks trading for less than $10 a share. Even the All-Stars in our 105,000-person-strong Motley Fool CAPS investor-intelligence database dabble in penny stocks. More than a few have been richly rewarded.

Finally, there's our Motley Fool Hidden Gems small-cap service. You won't often find penny stocks on its scorecard, but Foolish colleague Tim Hanson studies rising micro cap stars in a segment called Tiny Gems. Fuel-Tech (Nasdaq: FTEK  ) made Tim's list in December 2005. The stock is up more than 160% since.

Other former penny stocks that became multibaggers:

Company

Recent Price

CAPS Stars

(5 Max)

Five-Year Return

Intuitive Surgical (Nasdaq: ISRG  )

$288.65

*****

1,927%

Penn Virginia (NYSE: PVA  )

$55.64

****

462%

Chattem (Nasdaq: CHTT  )

$65.14

****

365%

ValueClick (Nasdaq: VCLK  )

$19.25

****

305%

Actuant (NYSE: ATU  )

$34.84

*****

250%

Sources: Motley Fool CAPS, Yahoo! Finance.

Pennies from heaven
So why not invest in penny stocks? I suppose because the SEC has warned us about them. But what if we take the agency's definition literally, and limit our choices to stocks trading between $1.50 and $5 a share? And what if we further limit our choices to four- and five-star CAPS stocks whose market cap doesn't exceed $2 billion, but is at least $250 million? Surely our new CAPS screener would return some winners, right?

This week, 28 made the cut. My favorite is Quest Capital (AMEX: QCC  ) , a Canadian mortgage and real estate financier that is raising its dividend just as others are cutting theirs.

To be fair, Quest says this is its first quarter as a mortgage financier. But if its recent earnings release is to be believed, management is thus far playing the game pretty well:

Generally loans are repayable over terms of 6 to 24 months, and bear interest at rates of between 10% and 14% per annum before commitment fees. Real property, real estate, and/or corporate or personal guarantees are generally pledged as security. [Emphasis added.]

Those are very good returns for a lender.

Obviously there's risk in investing in any firm that's getting into the mortgage financing business. There's simply less risk in Canada than there is here. Studies show the Canadian housing market slowing slightly, but a U.S.-style meltdown doesn't seem forthcoming. Not yet, at least.

CAPS All-Star MarkusV likes Quest's chances. Quoting from his pitch from September: "A play on the Canadian dollar appreciation VS USD (inflation pressure on the USD is very high following bernanke's decisions. …"

Interesting idea, but it hasn't worked out thus far; Quest is down nearly 19% since the pick. I think a rebound is likely. Institutions own less than 25% of the outstanding shares, and they'll buy by the bucketload, creating yet another penny-stock multibagger, if the thesis plays out over the long term.

But that's my take. I'm more interested in what you think. Would you buy Quest Capital at today's prices? Let us know by signing up for CAPS today. It's 100% free to participate.

See you back here in two weeks with another penny stock from heaven. Fool on!

Actuant is a Motley Fool Hidden Gems pick. If you're looking for more of the stock market's tiny titans, take a free 30-day trial to Hidden Gems. There's no obligation to subscribe.

Tim Beyers, who is ranked 15,112 out of more than 105,000 participants in CAPS, is a regular contributor to Fool.com and writes for Rule Breakers, which has recommended Intuitive Surgical to its subscribers.

Tim didn't own shares in any of the companies mentioned in this article at the time of publication. The Motley Fool's disclosure policy was once small and cuddly.


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