If you're thinking about buying penny stocks, you're not really investing. Instead, you're gambling on low-quality (or no-quality) companies. There's a chance prices will shoot up and make you a small fortune. But the most likely scenario involves your "investment" losing all or most of its value.
Investing in stocks is inherently risky, but you can reduce your risk by sticking to solid companies. Three of our Motley Fool contributors are here to help. Here's why they think Twitter (NYSE:TWTR), Skechers (NYSE:SKX), and TerraForm Power (NASDAQ:TERP) are great alternatives to penny stocks.
Back from the dead
Jeremy Bowman (Twitter): Investors look to penny stocks as a high-risk investment that could pay big returns. While most penny stocks, especially micro caps, turn out to be busts, investors can apply that psychology to the greater market, and I think one deserving target is Twitter.
Shares of the asymmetric social network have been on fire lately as the stock has more than doubled over the past year. Despite stagnating user growth, Twitter has gradually turned profitable by delivering greater value for advertisers and improving its platform with steps like suspending fake accounts. Improving the user experience is the company's biggest priority for growth and there's plenty of opportunity to make it better as it still struggles with things like harassment and can do much more to personalize its timeline.
Twitter was at one time seen as a potential equal to Facebook, and while the smaller network will never equal the reach of its larger peer, which now has over 2 billion users, Facebook's success shows the potential of Twitter if it can further develop business. Facebook's metrics crush virtually any other stock, with a profit margin of 40% and a market cap of $600 billion. As Twitter continues to improve its ad products and platform, profitability should follow.
The company has easily beaten earnings estimates in its last four quarters and trades at a forward P/E of less than 60 based on current analyst estimates. As a unique platform that has a valuable position in the global dialogue, the stock will continue to warrant a high multiple. If the company keeps beating estimates, the stock will move higher.
A rebound candidate
Tim Green (Skechers): Footwear company Skechers has not been a fun stock to own this year. After two disappointing quarterly reports and two massive declines, the stock is down 27% year to date. Since peaking in April, the stock has lost nearly 35% of its value.
Growth is slowing, and profits are under pressure as the company invests to keep sales chugging along in its international markets. Second-quarter sales grew by a respectable 10.6% year over year, but earnings per share plunged 24% despite an improved gross margin. The company is investing in its international business and its direct-to-consumer business, but rising costs no doubt have investors concerned.
Given the stock's performance and the company's issues, why do I think Skechers is a solid investment? The market is valuing Skechers like a slow-growing has-been, which I think is overly pessimistic. Based on the average analyst estimate for full-year earnings, Skechers sports a price-to-earnings ratio of about 16. And if you back out the $800 million of net cash on the balance sheet, the P/E ratio drops to just 13.
Skechers needs to eventually get the bottom line moving in the right direction again. If it doesn't, the cheap-looking valuation won't mean much. But given the beaten-down price, it won't take much good news to push the stock higher.
A rock-solid energy stock
Travis Hoium (TerraForm Power): Penny stocks can be exciting to speculate on, but in the long run, they aren't a great way to build long-term wealth. One company that will drive great returns is TerraForm Power, the owner of 3,640 megawatts (MW) of wind and solar assets. The projects have an average of 14 years remaining on contracts to sell electricity to utilities and other end-market customers, ensuring the company's long-term cash flows and a dividend for investors.
What's wonderful about yieldcos like TerraForm Power is that most of the excess cash generated by the business, after operating costs, goes back into investors' pockets in the form of a dividend. Management intends to pay out 80% to 85% of cash available for distribution as a dividend on an ongoing basis, keeping the rest to grow the company organically. It expects the dividend to be $0.76 per share in 2018, or a yield of 7.1%.
This isn't just a dividend that will be stagnant, either. Long term, management expects to grow dividends 5% to 8% annually as it buys more renewable energy projects around the world. The dividend alone can be a great return for investors willing to be patient and wait for their return, which is less stressful than betting on high-risk penny stocks.