For the past three months, there pretty much hasn't been a more popular penny stock on Wall Street than Canadian pot company Sundial Growers (SNDL -1.26%). Through this past weekend, shares of Sundial were higher by almost 550% since early November.
In recent weeks, the Reddit-based frenzy has been primarily responsible for pushing shares into the stratosphere. Sundial doesn't have the high levels of short interest that retail investors have been hunting lately, but it does have a low share price -- and that's an insatiable lure to millennial and novice investors.
Sundial Growers isn't worth your hard-earned money
The problem is that penny stocks -- public companies with a share price under $5 -- often trade at a low share price for a very good reason. Sundial Growers is no exception to that rule.
For example, the company has been aggressively paying down debt and bolstering its cash on hand by issuing stock and converting debt to equity. Following its latest registered share offering, it crossed the line to $600 million in cash on hand. However, in four months, Sundial Growers has managed to balloon its outstanding share count by 209%, or over 1 billion shares. Businesses that continually issue new stock or convert debt to equity can crush existing shareholders with dilution.
What's more, Sundial Growers is abandoning wholesale cannabis in favor of the higher-margin retail side of the business. Though that's probably a smart move logistically, it isn't going to happen overnight. In the meantime, year-over-year sales comparisons are way down, and the company is booking huge operating losses, many of which include one-time writedowns.
The reality is that Sundial Growers isn't a very good company.
But not all penny stocks are necessarily worth avoiding. Investors should strongly consider forgetting about Sundial and putting their money to work in the following companies, all of which are much better buys.
Don't let its sub-$5 share price fool you -- gold miner Yamana Gold (AUY 1.22%) is a $4.7 billion company masquerading at penny stock levels ($4.90 a share). It's also a company with serious macro and micro tailwinds.
Although the spot price of gold is down in recent months, the outlook for physical gold remains as strong as I've ever seen. The Federal Reserve intends to keep lending rates at or near historic lows through 2023, and it's supporting this vision with monthly Treasury bond purchases, which can push down long-term yields. When coupled with ongoing fiscal stimulus from Capitol Hill and a ballooning money supply, there are many reasons for investors to choose gold in the coming years.
But it's not just higher gold or silver prices that will drive Yamana's returns. It's on track to see a healthy uptick in production from the flagship Canadian Malartic mine in 2021, and is expected to benefit from higher output at the newer Cerro Moro mine. Yamana is pushing to deeper underground levels at Cerro Moro, which will lead to improved yield and production potential. All told, Yamana's management expects to produce at least 1 million gold equivalent ounces (GEO) in each of the next three years.
With gold prices up significantly over the past five years, Yamana has also been able to reduce its net debt by over $1 billion. Give the company a few more quarters at this 1 million GEO annual target, and it just might become net-cash positive.
Valued at roughly five times Wall Street's cash flow consensus for 2021, Yamana Gold looks like a bargain.
Invesco Mortgage Capital
Without getting too far into the weeds, mortgage REITs are companies that borrow at short-term lending rates and acquire assets like mortgage-backed securities (MBSs) that offer higher yields over longer periods of time. The difference between this higher long-term yield and the short-term borrowing rate is known as the net interest margin (NIM). The wider this gap, the more money mortgage REITs make.
During 2019 and early 2020, the yield curve was flattening, which harmed mortgage REITs by contracting their NIM. However, economic recoveries from a recession are often characterized by a steady steepening of the yield curve and an expansion of mortgage REIT NIMs. As NIM expands, companies like Invesco will use leverage to beef up their profitability.
Invesco Mortgage Capital was also doomed last year because its investment portfolio was filled with commercial mortgage-backed securities and other credit risk transfer securities. These are non-agency assets, which means they aren't backed by the federal government in case of default. When the coronavirus crash occurred in March 2020, Invesco simply didn't have the capital needed to cover its margin calls and it was forced to enter a forbearance agreement with its lenders.
The good news is that Invesco is out of forbearance, and its operating model is now purposely skewed to agency-only assets moving forward (those backed by the government in the event of default). Even though agency assets sport lower yields than non-agency, the company's NIM and leverage are safer than ever before.
Similar to Sundial Growers, OrganiGram is based in Canada. But unlike its peers, it's the only major grower headquartered in the Atlantic region of our neighbor to the north. Interestingly, even though Canada's Atlantic region provinces are less populated, adult cannabis use rates are much higher in these provinces and territories than the national average.
Aside from having a geographic advantage, OrganiGram's Moncton facility in New Brunswick stands out for a number of reasons. First, since the company only has one production and processing site, it can adjust its supply chain more easily than its peers. It also doesn't hurt that the company employs a three-tiered growing system, which should help reduce long-term per-gram production costs while maximizing yield per licensed room.
OrganiGram should fare well on the margin front, too. It spent an estimated $15 million Canadian on a line of fully automated equipment to make up to 4 million kilos of chocolate edibles each year. The company developed a proprietary beverage powder, as well. These higher-margin consumption options can help offset the lower margins and commoditization potential seen in value-based dried cannabis flower.
Compared to Sundial, OrganiGram is a night-and-day better company, and a much smarter penny stock to buy.
This article represents the opinion of the writer, who may disagree with the "official" recommendation position of a Motley Fool premium advisory service. We're motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.