The Next Million-Dollar Penny Stock

Penny stocks can make you rich.

Need proof? Every one of these multi-baggers was, at one time, a penny stock:

Company

Recent Price

CAPS Stars (out of 5)

5-Year Return

Southwestern Energy (NYSE: SWN  )

$32.45

***

1,252.1%

Arena Resources (NYSE: ARD  )

$23.50

***

691.2%

Ebix (Nasdaq: EBIX  )

$24.72

****

584.8%

EZCORP (Nasdaq: EZPW  )

$14.55

****

546.7%

Sun Hydraulics (Nasdaq: SNHY  )

$14.04

*****

295.5%

Sources: Motley Fool CAPS, Yahoo! Finance.

The promise of outrageous returns is why some of the world's best stock pickers are, at times, penny stock investors. Peter Lynch has enjoyed the stock market's super-cheap seats, and at times he still does. The Royce Low-Priced Stock fund crushes the market by betting on stocks trading near or below $10 a share, such as Cryptologic (Nasdaq: CRYP  ) .

Even the All-Stars in our 120,000-plus Motley Fool CAPS community take to penny stocks. More than a few have been richly rewarded.

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 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, 69 stocks made the cut -- including our last topper, Gushan Environmental. Let's move on to CapitalSource (NYSE: CSE  ) , which has a strong following in our CAPS community:

Metric

CapitalSource

CAPS stars (out of 5)

*****

Total ratings

1,717

Bullish ratings

1,650

Percent bulls

97.3%

Bearish ratings

67

Percent bears

2.7%

Bullish pitches

263

Bearish pitches

17

Data current as of Nov. 18, 2008.

As CAPS investor ValueArbitrage wrote in September:

Unlike so many commercial or investment banks today, CapitalSource is a bank with ultra low leverage and an outstanding team of managers who are focused on credit quality analytics for credit decisions, full use of collateral, and conservative lending practices (no 40x leverage and volume at any cost production processes here). Additionally, this company is currently going through a significant transformation, positioning itself to be both stronger and more profitable in the future.

Our Fool is referring to a shift in CapitalSource's business model. No longer will it be a REIT but a commercial bank. The FDIC has already approved its application, which leaves just the Federal Reserve standing in the way of its transformation. Most investors appear to believe that the Fed will step aside soon enough.

Once they do, CapitalSource will take on commercial lending business that -- due to the credit crisis -- has been vacated by others. A meaty and well-capitalized dividend, yielding 4.80% as of this writing, means that today's investors will be paid to wait for the higher profits that banking promises.

Years could pass before we see them, but it should happen eventually, argues TMFHelical. His study of management shows a history of very successful spin-offs and restructurings. "So while I still tire of hearing about the loaning 'opportunities' available in the market, I do have some confidence that management can indeed exploit them," he recently posted at the discussion boards for our Million Dollar Portfolio service.

Agreed, but I'm more interested to know what you think. Would you buy shares of CapitalSource at today's prices? Let us know by signing up for CAPS today. It's 100% free to participate.

See you back here next week with another penny stock from heaven. Fool on!

Each month, the Fool's Hidden Gems service spotlights promising micro-cap opportunities in a segment called Tiny Gems. Try this market-beating service risk-free for 30 days to find out what our penny-stock sleuths are following now.

Fool contributor Tim Beyers also contributes to the market-beating Rule Breakers service, whose recommendations include Ebix. CryptoLogic and Sun Hydraulics are Hidden Gems picks. CapitalSource is an Income Investor recommendation.

Tim owned shares of Gushan Environmental at the time of publication. The Motley Fool owned shares of CapitalSource. Its disclosure policy was small and cuddly. Once.


Read/Post Comments (4) | Recommend This Article (7)

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 November 20, 2008, at 5:13 PM, jhatlarge wrote:

    The Motley Fool has been leading their followers to financial demise as of late. The MDP their star portfolio is down a whopping 50+% with some positions down 85% + - A shell shock for those who paid $999 for the premium service. The Fool has been touting the Buffet way for years to gain investor confidence in subscribing to their service. The MF's lack of defensive strategy has killed MDP's performance and has tarnished the Buffet name so often used by the Fool to lure their subscribers. Would Mr. Buffet be a buyer of the MDP picks? That is the million dollar question, if so, at what price? Certainly not at the price touted by the Motley Fool to its MDP subscribers. Once more, how much of the Fools marketing is pure hype? It certainly has the makings of an irresponsible service to novice investors who are puting their confidence and hard earned money with MDP / MF hoping for a safer way to play the markets. Beware! Its not as rosy as it is made out to be. For many Foolish investors the $999 subscription is followed by sharp pain, one that has no instant relief.

  • Report this Comment On November 22, 2008, at 12:10 PM, MonsterZero71 wrote:

    Still hyping CRYP? Remember when it was your "stock of the year?" It's down more than 85% from then. Funny how there's no acknowledgment of the Motley Fool misses, only the hits.

  • Report this Comment On November 25, 2008, at 11:11 AM, GoNuke wrote:

    CSE has gotten rid of its business of lending to medical facilities which is where its niche expertise promised to generate above average earnings. That was the last straw. Now they are just another bank losing money. I sold this popular MF Income Investor pick today taking a 65% capital loss. There are lots of real bargains out there. Since I am fully invested so I have dumped this stock to invest in more promising ventures.

    Frankly I doubt that CSE will continue to pay dividends for a while but I don't think Mr. Market has priced that eventuality into its current share price.

    I have cancelled my subscription to Income Investor.

    My condolences to all fellow fools who embraced MF's enthusiasm for this stock. I doubled down on it twice to take advantage of its medical lending business. Hospitals need to borrow money to buy da Vinci robotic operating machines from Intuitive Surgical, another company beloved by the Motley Fool.

    Invest in oil, they have stopped making it.

  • Report this Comment On November 26, 2008, at 2:48 PM, TechCA wrote:

    MonsterZero - MF tracks their failures as well as their successes for all to see but of course if you want to sell subscriptions you're going to put your successes front and centre. I've seen postings from Tom et al admitting when they were wrong and pointing out what they've learned as a result. Also, they're just recommendations made by people with their own views of the world, and subject to the same errors that all of us are. They can't predict the future, just as money managers and economists around the world (supposedly people in the know) couldn't have predicted what we're seeing today. That together with a few management missteps from cryp that all the analysis in the world could never uncover are the reasons this one's down. The research done at the time was solid and thorough, and MF has updated it's opinion continually as things have shifted for CRYP.

    Things change is new data becomes available and in the end, it's up to do your own due diligence and decide whether a recommendation from MF is credible or not. If its not, you're free to discuss it on the boards - and I don't see any contrarian advice from you when CRYP was doing well. No one ever made any claims that MF was infallible, either.

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