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Forget Penny Stocks -- 3 Better Stocks to Buy in October

By Nicholas Rossolillo – Oct 4, 2020 at 7:30AM

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A company's market cap is far more important than share price when looking for potential winning stocks.

With promises of huge upside in a short period of time, many investors get pulled into purchasing penny stocks -- very small market cap companies with shares that typically trade for a few dollars or less that often have little in the way of revenue or profit. But most of these get-rich-quick-scheme stocks never pan out. 

Rather than focusing on the share price as an investing standard, investors looking for a big upside should instead consider companies with small market caps (share price multiplied by the number of shares outstanding) operating in big industries.

Three companies offering a better alternative than penny stocks you should consider in the month of October are Limelight Networks (EGIO 2.04%), Nano-X Imaging (NNOX -2.19%), and Zynga (ZNGA).

A woman in thought with a thought bubble and bag of money illustrated over her head.

Image source: Getty Images.

1. Limelight Networks: Moving global video streaming traffic

The internet has been put to the test during the COVID-19 pandemic. Web traffic has surged as businesses have rapidly switched to remote operations, and increased time at home has led to higher use of web-based video among consumers. This has been a boon for content delivery networks (CDNs), the infrastructure companies responsible for moving and securing data transmitted across the internet. 

That includes a small player in the CDN space, Limelight Networks. Even after increasing more than 40% in value in 2020 to-date, the company has a market cap of just over $700 million as of this writing. And after reporting second-quarter 2020 results and announcing a $110 million debt offering to raise more cash, shares are nearly 30% off all-time highs (though the stock is still up over 40% year to date).

That fresh cash will come in handy as this small company tries to maximize its growth potential. It already counts among its customers streaming services like Disney+, Comcast's Peacock, and AT&T's HBO Max. Limelight is also being tapped by educators and education technology companies to help enable remote learning. And the company's new edge networking service (where data gets pushed close to the end-user to improve online performance) also recently went live.

Through the first half of 2020, Limelight's revenue is up 30% year over year to $116 million, and full-year guidance is calling for a 17% increase in revenue to $235 million (at the midpoint of expectations). This small CDN runs little in the way of profits right now, but with it priced at just 3.0 times trailing 12-month sales, there could be plenty of upside here if the company continues to expand along with global internet usage.

2. Nano-X Imaging: A speculative health tech stock with massive potential

Penny stock fans rejoice: This next pick is a speculative one, as it has no revenue but a current market cap of just under $1 billion as of this writing. Nano-X Imaging is a start-up that has developed a novel way to generate x-rays for use in medical imaging. Paired with its cloud analysis and billing system, the company claims to have a way to revolutionize x-ray imaging and patient access to early detection of health issues, as its system costs pennies on the dollar compared to a traditional x-ray machine.  

Though there are no sales as of yet, U.S. Food and Drug Administration (FDA) approval is in the works (perhaps by 2021), and it has a roadmap to deploy 15,000 of its x-ray systems once they're cleared for use. After raising $190 million in its IPO and with backing from global tech companies like Korea's SK Telecom and iPhone manufacturer Foxconn, Nano-X says it has $244 million in cash on the books. The first 15,000 machines will reportedly only cost $144 million to $194 million to manufacture, with the leftovers earmarked for general operating purposes.

After it went public in August, investors piled into the promising health tech outfit, and shares tripled in value. The stock has since reversed course, though, following negative reports from short-sellers Citroen Research and Muddy Waters calling Nano-X a fraud. The egregious claims likely aren't true, although investors may have been getting way ahead of themselves with the big run-up in Nano-X stock before FDA approval has even been granted.  

But given that shares have come tumbling back to earth, now looks like an appropriate time to start dipping a toe in the water. Keep any initial position small and buy more over time -- assuming at least some of Nano-X's plans start to show signs of panning out. But if this is a revolutionary way to increase access to medical imaging and early-stage detection, this one is worth having a small stake in before the ball really starts rolling. 

3. Zynga: A small but profitable mobile video game developer

On to mobile video game developer Zynga, the only real profitable business on this list. Video games have been on fire this year. Increased time spent at home has led to more screen time for players, and higher sales for game producers -- Zynga included.

Building on its success so far in 2020, the company known for Words With Friends, Farmville, and CSR Racing has been busy over the summer months. It acquired fellow mobile developer Peak (Toy Blast and Toon Blast) for $1.8 billion and followed that up with taking an 80% stake in Rollic (Go Knots 3D, Tangle Master 3D).

After its acquisitions are all said and done, Zynga will have a few hundred million in cash and equivalents leftover (it had $1.56 billion at the end of June, and paid for half of Peak with the issuance of new stock) and $583 million in convertible debt. That leaves this video game outfit in solid financial shape, and it has a current market cap of $10.3 billion (valuing shares at 5.7 times trailing 12-month sales). This could be a real value in the gaming industry. Before adding in results from Peak and Rollic, Zynga's revenue grew 49% through the first half of 2020.

As previously mentioned, this stock offers more than all-out growth. It's also profitable. Zynga generated free cash flow (revenue less cash operating and capital expenses) of $247 million over the last trailing 12-month stretch on revenue of $1.61 billion -- good for a free cash flow profit margin of 15%. That metric will dip in the coming year as the company digests its purchases of Peak and Rollic, but this small video game firm is nonetheless in good shape to continue its expansion with its profitable operations. And with video games only rising in popularity around the globe, this stock could have a lot of upside in the years ahead.

Nicholas Rossolillo owns shares of Comcast, Limelight Networks, Nano-X Imaging Ltd., Walt Disney, and Zynga. His clients may own shares of the companies mentioned. The Motley Fool owns shares of and recommends Walt Disney and Zynga. The Motley Fool recommends Comcast and recommends the following options: long January 2021 $60 calls on Walt Disney and short October 2020 $125 calls on Walt Disney. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Zynga Stock Quote
Edgio, Inc. Stock Quote
Edgio, Inc.
$1.50 (2.04%) $0.03
Nano-X Imaging Ltd. Stock Quote
Nano-X Imaging Ltd.
$10.70 (-2.19%) $0.24

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