If you're trying to build wealth, then you should absolutely avoid buying penny stocks. Individuals drawn to the low, low share prices offered by micro-cap companies often let emotions get the best of them and fail to accurately characterize the risk involved.
Rather than gambling away your hard-earned money, it makes more sense to invest in sound businesses at great prices. To be blunt, that can be a little boring. So, if you want to have a little fun and potentially earn an eye-popping return, then consider buying a small stake in a risky small-cap stock with promise. Here's why Pacific Biosciences (PACB 0.67%) and Avid Bioservices (CDMO -1.07%) may fit that label.
A failed merger, but a rapidly improving technology platform
It appears that the merger between Illumina (ILMN 1.57%) and Pacific Biosciences will be nixed by trade authorities in the United Kingdom and the United States. At first glance, it's easy to think that's a worst-case scenario for the small-cap DNA sequencing company. Shares of Pacific Biosciences currently trade well below the proposed acquisition price of $8 apiece, while the business was on track to lose over $100 million from operations in 2019.
But a closer survey of the details leaves much room for optimism. If the merger fails, then Pacific Biosciences could earn a $98 million termination fee (with some strings attached). While it has by no means proven itself as a sound investment in the last decade, the scientific community would gladly use the company's newest Sequel II machines interchangeably with -- or even instead of -- those offered by Illumina if the economics were right.
Intriguingly, it appears that recent technology upgrades are lowering costs for the platform just as the merger with Illumina is unraveling. Pacific Biosciences reported a 117% year-over-year increase in gross profit in the third quarter of 2019. Considering that sequencing costs on the Sequel II could potentially be much lower with continued technology upgrades than what Illumina can offer, the recent trend could be one worth watching for investors.
Pacific Biosciences is definitely a risky small-cap stock. But if the company's unique sequencing approach finally lives up to its potential, then it could become the go-to platform for reading DNA for personalized medicine applications. That could make it a prime acquisition target by another industry player such as Roche or Agilent or even 10X Genomics. It would also likely earn the business a market valuation above its current $800 million market cap. Investors willing to stake a small position in the stock could be rewarded for their patience.
Moving in the right direction
Most investors have probably never heard of Avid Bioservices. The $450 million company is a contract development and manufacturing organization (CDMO) that helps pharmaceutical customers develop drug manufacturing processes and manufacture active pharmaceutical ingredients. It struggles from choppy revenue generation due to the fact that its business model hinges on contracts, and it has never generated a profit, but the business appears to be heading in the right direction.
In the fiscal second quarter of 2020 (the three-month period ending Oct. 31), Avid Bioservices reported greatly improved financial results. The company reduced its quarterly operating loss to just $529,000, compared to an operating loss of over $3 million in the fiscal first quarter of 2020. Fiscal first-half 2020 gross margin nearly doubled compared to the year-ago period, while revenue jumped 47% in that span.
Importantly, the CDMO is planning to make important facilities upgrades during the fiscal year that should help it land more and larger contracts. Avid Bioservices recently opened a process development lab to aid customers in scale-up and troubleshooting efforts, while a new pharmaceutical-grade water system should be operational by the year's end.
The business expects fiscal full-year 2020 revenue of only $64 million to $67 million, but if it can achieve consistent operating profits in the next year or so, the company will have significantly improved financial flexibility. If the CDMO uses that leverage to expand operations or capabilities, it could rise above its current $450 million market cap. Investors willing to open a small stake in the business could be rewarded under the right conditions -- something that virtually never happens with penny stocks.