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
(5 stars max.)

5-Year
Return

Graham (NYSE: GHM  )

$8.12

****

294.2%

Iconix Brand Group

$7.71

***

228.1%

Smith & Wesson Holding (Nasdaq: SWHC  )

$3.66

****

137.7%

Arena Resources

$21.40

****

560.5%

Almost Family (Nasdaq: AFAM  )

$22.67

****

412.9%

Sources: Motley Fool CAPS, Yahoo! Finance.

The promise of outrageous returns has periodically made even the world's best stock pickers penny stock investors. Peter Lynch has enjoyed the stock market’s super-cheap seats in the past, and at times he still does. The Royce Low-Priced Stock fund has beat the market for a decade by betting on stocks trading near or below $10 a share, including Sigma Designs (Nasdaq: SIGM  ) .

Even the All-Stars in our 125,000-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 when I ran it, 83 stocks made the cut -- including our last topper, Accuray. Let's move on to Rackspace Hosting (NYSE: RAX  ) , which has a small but mostly bullish following in our CAPS community:

Metric

Rackspace Hosting

CAPS stars (out of 5)

****

Total ratings

95

Percent bulls

92.5%

Percent bears

7.5%

Bullish pitches

16 out of 18

Data current as of Feb. 27, 2009.

On the surface, the business sounds awful. Hosting? That's soooooo ’90s. Except that it isn't. Thanks to Google (Nasdaq: GOOG  ) and Amazon.com (Nasdaq: AMZN  ) , among others, more business than ever is moving to the cloud. Rackspace is an enabler for those aiming to join the party.

And it's good business. Last week, Rackspace reported big gains in revenue and earnings during the fourth quarter. Revenue improved 34% to $143.1 million, while per-share earnings tripled to $0.06. Both numbers beat the Street's consensus estimates.

They also add heft to comments made by industry veteran and CAPS investor pesk in November. "They rate themselves as one of the only dogs that can provide the same level of hosting services as the IBM's and AT&T's out there, while being the only company in that category that offers entry level solutions," he wrote. Continuing:

This sounds like the cheapest house in the best part of town. While their service and business model may tend towards an expensive operation, these guys are not inexpensive.

As a customer who has tried the 'clouds' and VPS services out there, these guys deliver 10x the service and technology and I am happy to pay a high premium for it. It is this high premium that I believe will keep this a strong company into the future.

Color me impressed. But I'm also just one Fool. I'm far more interested to know what you think. Would you buy Rackspace 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!

Fool contributor Tim Beyers contributes to the market-beating Rule Breakers service, which counts Google and Sigma Designs among its recommendations. Amazon.com is a Motley Fool Stock Advisor pick.

Tim had stock and options positions in Google and a stock position in IBM at the time of publication. Check out his portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. Its disclosure policy was small and cuddly. Once.


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