Penny stocks may seem like a good way to get rich in the stock market, but more often than not, they're nothing but a good way to watch your money disappear. There are literally thousands of stocks and funds you could invest in that are better choices than penny stocks, but here's why three of our contributors think Goldman Sachs (NYSE:GS), Financial Select Sector SPDR (NYSEMKT:XLF), and Capital One Financial (NYSE:COF) are particularly attractive alternatives right now.
A big Wall Street bet
Dan Caplinger (Goldman Sachs): People invest in penny stocks because they hope to get rich quick, but it's usually the promoters behind those penny stocks that end up being the big winners. That bet-on-the-house mentality goes a long way toward supporting an investment in Goldman Sachs, which has long been one of the most prestigious investment banks on Wall Street. It's rare to be able to pick up shares of the banking giant at a discount, but recent pressures on Goldman have sent its stock substantially lower in 2018.
Goldman has had to deal with multiple issues that have held back its performance recently. The company relies on healthy results from its proprietary trading operations, but Goldman hasn't lived up to its reputation lately, posting poor numbers. The investment bank has also faced litigation regarding one of its projects in Malaysia, and it might have to pay back all of the fees that it earned from that piece of business and face further reputational damage to boot.
Yet the drop in Goldman's stock has left it looking like a good value. Shares trade below book value, and although forward earnings projections might be somewhat rich, you can buy Goldman stock at just seven times what most investors expect the bank to earn in 2019. That gives you a huge margin of safety that should provide cover even if the U.S. economy slips into a recession, and Goldman stands to bounce back strongly if it can get back its winning ways on the trading front and take maximum advantage of its new opportunities in consumer banking.
Another way to bet on the house
Matt Frankel, CFP (Financial Select Sector SPDR): I love Dan's call on Goldman Sachs and the "bet on the house" thesis. I think Goldman is extremely undervalued at current levels.
That said, there is a lot of legal uncertainty hanging over the bank, so I'd like to present an alternative for investors who don't necessarily want to bet on just one "house." Most banks are trading at depressed valuations after the recent stock market correction, which disproportionally affected banks, so I feel like there's a lot of upside potential in the entire sector.
The Financial Select Sector SPDR ETF is an exchange-traded fund that tracks the financial sector as a whole. It is a market cap-weighted fund, so larger companies make up a greater percentage of the fund's assets. Top holdings of the fund include Berkshire Hathaway (yes, it's technically in the financial sector), as well as big banks JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup, plus smaller holdings in many other U.S. banks. In a nutshell, when banks do well, you'll do well.
The fund has a rock-bottom 0.13% expense ratio, so most of the fund's gains will stay in your pocket. So if you feel, like I do, that there's tons of potential for upside in the banking industry, but don't really want to rely on a single company's performance, the Financial Select Sector SPDR ETF could be a smart addition to your portfolio.
Credit this stock
Jordan Wathen (Capital One Financial): Best known for its credit cards, Capital One Financial has morphed from a card company to a true consumer and commercial banking institution. Through smart acquisitions, Capital One now competes in everything from credit cards to commercial loans, creating a bigger bank that looks nothing like it did as a late 1980s start-up.
Though credit cards (46% of loans) remain its bread and butter, its growing commercial loan book (29% of loans) and consumer lending products (25% of loans) have helped diversify its balance sheet. Its consumer banking unit is also an attractive deposit-gatherer, helping the bank reduce its funding costs by providing a consumer-friendly online bank to tech-savvy savers.
And though the market may be turning a cold shoulder to credit card stocks due to the fear of recession, Capital One is unlikely to be the lender to worry about. During the 2008 financial crisis -- the best stress test for any bank -- Capital One was consistently profitable, earning sufficient returns on its high-yielding card loans to paper over the inevitable increase in loan losses. Plus, with ample deposits, Capital One isn't nearly as reliant on the health of the financial markets to fund its balance sheet, alleviating one financial crisis-era problem spot.
After sliding roughly 30% from their 2018 peak, Capital One shares now trade at little more than six times what the bank could reasonably earn this year. Loan losses may rise from here, but the low valuation makes the risk-reward proposition pretty attractive for investors willing to stomach near-term pain for long-term gain.
Dan Caplinger owns shares of BRK-B. Jordan Wathen has no position in any of the stocks mentioned. Matthew Frankel, CFP owns shares of BAC and BRK-B. The Motley Fool owns shares of and recommends BRK-B. The Motley Fool has a disclosure policy.