Penny stocks are like lottery tickets -- a way to turn small sums of money into massive amounts of money, assuming everything goes right. But like lottery tickets, the majority of penny stocks turn out to be losers, overshadowing any gains from the very few winners.
The simple fact is that most stock market wealth is made the old-fashioned way -- by buying shares of good companies that you can hold for the long haul, rather than flipping cheap stocks for a quick buck. Here, three Fools lay out the case for Leucadia National (NYSE:JEF), Wheaton Precious Metals (NYSE: WPM), and Home Depot (NYSE:HD) as attractive stocks for investors who want something more than just another scratch-off ticket.
Get a real value
Dan Caplinger (Leucadia National): Value investors often like the idea of penny stocks because they see low-priced shares as an opportunity to cash in on bargain-basement valuations. Yet the better way to capture value is to find companies that look for such opportunities as ways to grow their businesses.
Leucadia National has repeatedly made such moves, with the conglomerate having put together such disparate businesses as brokerage company Jefferies Group and beef producer National Beef under a single corporate umbrella. That's provided both diversification and protection from cyclical factors that affect each of those businesses separately, and stakes in a variety of smaller operations have also contributed to Leucadia's overall success.
Leucadia has also been bold when opportunity strikes. Its bailout of foreign exchange brokerage specialist FXCM was controversial in early 2015, stemming as it did from unprecedented moves in the value of the Swiss franc against the euro and other major foreign currencies. Yet the investment has produced huge profits, and Leucadia still has a position in FXCM that could benefit even more if the foreign exchange specialist can keep improving its operations.
With an eye toward value-smart investments, Leucadia is a great way to avoid wasting money on penny stocks. Its focus on operating strong businesses and looking for ways to grow adds value for its shareholders.
This royalty company could outshine penny stocks with ease
Sean Williams (Wheaton Precious Metals): With penny stock gains often fleeting, I'd suggest investors consider a far safer company with aspirations of becoming a large-cap stock, such as Wheaton Precious Metals.
I'm a fan of precious metals. However, betting on a specific mining company isn't always the smartest play, even if gold and silver prices continue to rise. But Wheaton Precious Metals isn't your average mining company, in that it doesn't actually engage in the day-to-day operations of any mines. Instead, it's a royalty play on precious metals that acts as a financer for mining companies looking to build out a new mine or expanding an existing asset.
Here's how it works: Wheaton provides a large up-front sum of cash that the mining company will use to develop or expand a mine, and in return Wheaton Precious Metals receives a percentage of production for a long period of time, occasionally for the mine's life. The key here is that Wheaton receives this production well below market rate. It then turns around and sells the metals at market rates, pocketing the difference as profit.
How successful is this business model? It paid its production partners an average of $4.43 an ounce for silver and $396 an ounce for gold, according to the company's third-quarter operating results. Comparatively, it sold these metals at an average price per ounce of $16.87 for silver and $1,283 for gold during the third quarter, which works out to a $12.44-per-ounce gross margin on silver and an $887-per-ounce margin on gold. Finding margin like this in the precious-metals industry is nearly impossible.
Perhaps best of all, Wheaton Precious Metals is diversified, with numerous deals on its books. This suggests that struggles at one of its producing properties wouldn't derail its overall operating results. Sporting ridiculously high margin and a dividend yield of nearly 2%, Wheaton Precious Metals is a stock that should make investors forget all about penny stocks.
A stock fit for a hall of fame
Jordan Wathen (Home Depot): Easily the best of the retail bunch, Home Depot is in a category of its own. The company benefits from scale in home improvement goods, making it the low-cost supplier for everything from nails to toilet bowls.
Home Depot is lucky to find itself in a business where competitors are rational. Both Home Depot and Lowe's generate gross margin of about 34%, though Home Depot generates superior returns because it turns its inventory faster than its peer. Neither is particularly aggressive in competing on price, especially compared with other retail segments, like groceries, where price competition is the name of the game.
I see Home Depot as one of the few retailers that should thrive even in a world where retail sales are increasingly moving online. While shoppers may buy shoes or toothpaste over the internet, home improvement products don't lend themselves to easy transportation. Furthermore, products like paint are more likely to be purchased in person, where customers can see what it looks like before taking it home. To be clear, Home Depot isn't letting e-commerce pass it by, as it recently reported that about 6.7% of its sales can be attributed to digital channels.
Shares rarely trade cheap, and they currently go for about 22 times free cash flow. But I believe investors can generate an attractive return powered by single-digit sales growth, margin expansion, and capital allocation that favors dividends and repurchases over new store openings.