There is a certain allure to penny stocks. The idea of loading up on a mountain of shares that trade for a couple of dollars (or less) and watching the stock skyrocket is almost akin to having a winning lottery ticket. Problem is, penny stocks are also like the lottery because probably one in a few thousand actually pay off and you are likely going to waste a lot of money trying to chase that one winner.
For people looking to build wealth, penny stocks simply aren't worth it. You're better off pursuing well-run businesses and letting the power of their earnings grow your position over the long haul. So we asked three of our Motley Fool investors to choose stocks they like right now that would be good alternatives. Here's why they picked Cleveland-Cliffs (NYSE:CLF), Apple (NASDAQ:AAPL), and Franco-Nevada Corporation (TSX:FNV).
Priced like a penny stock, but is so much more
Tyler Crowe (Cleveland-Cliffs Inc.): I can understand why investors would want to avoid North American iron ore supplier Cleveland-Cliffs. Under the previous management team, it made several ill-advised investments right at the peak of the commodity boom in 2010 that nearly sank the company. Today, though, the company is back from the brink and is poised to be a great investment over the next several years.
One of the biggest steps that Cleveland-Cliffs made to become an investment-worthy stock was to focus on its North American iron ore operations. Supplying iron ore to American steelmakers is a commodity business, but these facilities get a sizable price premium to imported iron ore because transportation costs are so high for imported product. Cleveland-Cliffs supplies 55% of the nation's iron ore and has used that position effectively to reduce the company's debt load and position it for growth again. It currently has plans to expand with new mines and a hot-briquetted iron refining facility that will allow the company to supply newer steelmaking facilities that require a higher grade ore.
Despite the monumental strides the management team has made to streamline the business and get its balance sheet back to fighting weight, Wall Street has still been shying away from this stock as shares trade at an enterprise value-to-EBITDA ratio of 10 times. If investors are willing to take a wild ride, Cleveland-Cliffs could be the kind of stock that generates significant returns over the next few years.
The opposite of a penny stock
Travis Hoium (Apple): Rather than buy a portion of a small company through a penny stock, I think a better financial move would be to buy one of the biggest companies in the world.
Apple is arguably the most influential tech company of this generation, and it's become an indispensable portion of millions of people's lives, building an incredibly profitable business in the process. The core of its business today are iOS devices like the iPhone and iPad and they create the foundation of an ecosystem that Apple uses to draw in customers and keep them coming back for more of their tech needs. From iPhones, iPads, and Macs, Apple is expanding its reach into our everyday lives with products like AirPods, Apple Watch, and the HomePod and services that link all of its devices together like Apple Music, iCloud, iTunes, and the App Store. These products and services all grow and leverage the installed base of iOS devices to generate more revenue for Apple each year. You can see that the success of iOS devices have driven over $50 billion in annual net income and free cash flow for Apple.
On top of its cash-generating business, Apple has $145.4 billion of net cash on its balance sheet, ensuring a long-lasting operation and financial stability for long-term investors versus more leveraged companies. When you add in its dividend of $2.92 per share, which was just increased by 16% early in 2018, Apple is one of the best companies for investors to own long term. It's certainly better than buying penny stocks today.
Opportunity in gold and oil
Reuben Gregg Brewer (Franco-Nevada Corporation): Investors looking at penny stocks are often attracted to the upside potential offered by natural resource plays like tiny gold miners and oil wildcatters. Usually, these risky penny stocks have little in the way of current operations, but huge promise if mines and wells in the works pan out as planned. This is where Franco-Nevada comes in.
Franco-Nevada is a streaming and royalty company that invests in both gold and silver mines (roughly 80% of revenue) and oil and gas wells (around 10% of revenue). Essentially, it provides cash up front to miners and oil drillers for the right to buy gold, silver, oil, and natural gas in the future at reduced rates. It has a large portfolio of active assets today, with 50 producing mines and 57 producing energy investments. However, some of its other assets will be more interesting if you are looking at penny stocks.
In addition to those operating assets, which provide a current return and support future growth investments, Franco-Nevada has 36 mines in an advanced stage of development and 25 oil and gas exploration investments. There are another 208 mines that are in the exploration stage. Just like a penny stock miner or wildcatter, Franco-Nevada stands to benefit materially from successes at any of these more than 270 investments.
Perhaps best of all, with one investment, you get diversification across a huge number of promising, professionally vetted properties. That's a much better option than betting on a penny stock with just one make-or-break project.