Investors who buy penny stocks tend to be seeking explosive returns. While it's possible to see incredible performance from these companies over a short period of time, the limited amount of visibility into their operations and outlooks means that you're often at a disadvantage and likely to lose out over the long term.
With that in mind, we put together a panel of three Motley Fool contributors and tasked each member with profiling a stock that offers excitement and big return potential -- and much better chances of success than you're likely to find trolling for penny stocks. Read on to see why they think that investing in Disney (NYSE:DIS), Stamps.com (NASDAQ:STMP), and iQiyi (NASDAQ:IQ) could have big payoffs.
Wish upon this star
Demitri Kalogeropoulos (Disney): One of the biggest knocks against buying penny stocks is that these "investments" often amount to gambles on short-term stock price swings rather than any affirmative bet on the power of the underlying business. The odds are stacked against you in that arena, so why not take the longer view on a company you know well and that you perhaps routinely pay in exchange for entertainment experiences?
Disney recently kicked off a new fiscal year that was marked by sharp earnings declines due to an unusually weak movie release schedule. But make no mistake: The House of Mouse has its sights set on a big 2019.
New blockbusters from the Marvel, Disney, Pixar, and Lucasfilm studios are on the way, for one. The entertainment titan plans to attack the over-the-top streaming video market with additions to its ESPN Plus service and the upcoming launch of Disney+. And the acquisition of 21st Century Fox should solidify its place at the top of global box office results for many years to come, all while its theme parks continue flexing their impressive pricing muscle.
All of that amounts to what could be unusually high earnings volatility in the coming quarters. But with a Disney purchase, as opposed to penny stocks, investors have a good idea of the risks they're taking on in owning a piece of this stellar business.
A stamp costs 55 pennies, but Stamps.com is worth much more
Rich Smith (Stamps.com): Before taking a flyer on a penny stock, I think it's worth first asking why no one is willing to pay more than a few pennies for it in the first place. Maybe it's because the company has no profits. Maybe it's because it has no revenue. Or maybe it's because the company's business is so vulnerable to competition that its profits and revenues are seen as vulnerable.
None of that's true for Stamps.com.
Having pioneered the "print your own stamps" business nearly 25 years ago, Stamps.com today is a dominant force in shipping. In fact, it's one of only three companies that the USPS currently allows to sell printable postage online, creating an automatic "moat" to defend the business from too much competition.
As a result, Stamps.com boasts strong and growing revenues -- $549 million over the past year and more than twice what it sold three years ago; strong profits -- $166 million and more than twice what it earned two years ago; and strong free cash flow (FCF) of $206.5 million -- nearly five times 2015 FCF.
Against all this, Stamps.com still has a market cap of only $3.4 billion, leaving it plenty of room to grow. (And analysts predict Stamps.com will grow earnings at 18% per year over the next five years.) With a cheap valuation of just less than 21 times earnings and less than 17 times FCF, I think the stock is a better buy than just about any penny stock you can name.
A potentially high-reward play in streaming video
Keith Noonan (iQiyi): Penny stocks are known for being high-risk, high-reward plays, and investors who are drawn to that basic dynamic could find a lot to like about iQiyi. The Chinese streaming video company made its market debut last March and saw its share price climb more than 150% from its $18 IPO price to reach $46 per share last summer as impressive sales growth and excitement that the stock could become China's Netflix helped propel big gains. A sharp trek into bearish territory for Chinese tech stocks and mounting losses for iQiyi's business have since caused some investors to flee the stock, but it's too early to count the company out.
While slowdown for the Chinese economy creates a less favorable backdrop for iQiyi, the more pressing concern is probably the rate at which the business's losses have accelerated. The company is spending big to purchase and produce content for its platform, and this push has caused its net loss to rise from $63.1 million in the first quarter to $316.9 million in the second quarter and $457.3 million in the third. The upside is that iQiyi is rapidly expanding its user base, and companies like Netflix have shown that prioritizing member growth over near-term earnings performance can pay off.
The company had more than 80.7 million paid subscribers on its rolls at the end of September, up 89% compared to the prior-year period. It also has a nonpaying audience of roughly 400 million people who it reaches through its free, ad-supported offering. If the company can continue to expand its subscriber base and increase average revenue per user through pricing hikes and microtransactional purchases, iQiyi stock could climb to new heights. There's still considerable guesswork involved in charting iQiyi's trajectory, but for investors seeking big growth, its stock offers a better risk-to-reward dynamic than you're likely to have picking penny stocks.