Why do some stocks trade in the single digits? Often a stock is cheap because it's a loser company, and the market has priced it accordingly. It's always dangerous investing in subpar penny stocks.
On the other hand, the market is not omniscient. Sometimes stocks you want to own are surprisingly cheap. For instance, if a strong company has a really bad year because of COVID-19, its stock price can be hammered. That's what happened to shares of Rolls-Royce (RYCEY -2.72%).
Or a micro-cap biotech can have some amazing news and the market is oblivious. I think that's the situation with Pieris Pharmaceuticals (PIRS -2.77%).
Or you might find a company that's not cheap at all -- it's just the share price that's a bargain. For instance Kahoot! (KHOT.F) has a price-to-sales ratio of 76. So it's a highly expensive stock that's trading for $7.
All three of these stocks are buys, in my opinion. Here's why I'm bullish.
Image source: Getty Images.
1. Rolls-Royce will come back
Back in 2019, shares of British aerospace giant Rolls-Royce changed hands at over $12 a share. Now you can buy a share for a little over $1.50. To say that COVID-19 hurt this company is an understatement. In 2020, the aviation industry was shut down around the world. At one point, American aerospace giant Boeing lost about 75% of its market cap. It's been a bloodbath for the whole sector.
Of course, Rolls-Royce is far from a microcap, even after its stock was obliterated. Despite its penny-stock status, the company has a $13 billion market cap. What sent the share price so low was a massive share offering last year that diluted existing shareholders. The company felt the need to do that as it was bleeding cash. The business had negative cash flow of 2.8 billion pounds (about $3.9 billion) in the first half of 2020. So Rolls did a secondary offering, diluting existing shareholders about 77%.
Not surprisingly, Rolls also suspended its dividend for the first time since 1987. So existing shareholders have been disappointed by the company, and I don't blame anyone for skedaddling. But for outsiders who have been watching from a distance, Rolls stock is looking pretty interesting.
This is a company that's been around since the 19th century. The company's Silver Ghost was hailed as "the best car in the world" in 1906. Rolls built the engine for the Submarine Spitfire, the plane that defeated Adolf Hitler in the air over London in World War II. In 1953, Rolls entered the civil aviation market. In 1960, the company introduced the world's first turbofan jet engine. Now it's one of the largest manufacturers of jet engines in the world. (Rolls sold off its car business in 1998.)
The company has reduced its burn rate by 1 billion pounds, while simultaneously acquiring an additional 7 billion pounds in liquidity. That's more than enough to carry it through the pandemic. Management predicts the company will be cash flow positive next year. Investors willing to take a little risk now should be rewarded handsomely as the aviation market opens up again.
2. This micro-cap biotech has a lot of big-name partners
If you're buying a biotech without profits and revenue -- a highly risky thing to do -- it's probably a good idea to shop in the cheap section. These are the stocks that Wall Street is ignoring. So while value investors like Warren Buffett wouldn't touch biotech stocks with a 10-foot pole, you can nonetheless do very well by thinking like a value investor in this sector.
Pieris Pharma has a $240 million market cap and is trading for $3 a share. It's a quintessential tiny biotech company, and Wall Street isn't paying any attention. But a lot of other biotech companies are noticing Pieris, and they want to develop drugs with the company.
Pieris has collaboration agreements with AstraZeneca, Boston Pharmceuticals, Servier, and Seagen. And it just signed a major deal with Genentech, now part of Roche.
What's generating this desire to collaborate with Pieris is the biotech's focus on lipocalins, proteins that naturally bind and transport molecules throughout the human body. The biotech has developed its proprietary Anticalin tech based on its scientific discoveries. Pieris has two main focuses right now: cancer and respiratory diseases.
Pieris has received $175 million in upfront and milestone payments so far from its biotech partners. While it's early in this company's journey (its lead molecule is in phase 2), the company might receive almost $9 billion if future milestones are met. And that does not include royalties if the drugs are successful. Pieris also has two drugs that it's kept in-house, including its lead oncology molecule, PRS-343, about to enter phase 2 trials later this year.
Kahoot! is making education fun
Kahoot! is a software-as-a-service (SaaS) company based in Norway. The company offers a gaming platform that makes education a competitive sport. Over 1.5 billion people around the world have played a Kahoot! These are visual and colorful multiple-choice trivia games in subjects like music, sports, hard sciences, and world history.
The company has a freemium model that allows you to play for free, advance to the family plan for $5 a month, or choose premier play at $15 a month. On the corporate side, Kahoot! offers corporate trainers and presenters a variety of software plans from $17 a month (20 participants) up to $59 a month (2,000 participants). Ninety-seven percent of the companies in the Fortune 500 use Kahoot!
Right now the company has 500,000 paying users. Revenue is still low, at $45 million last year, but it's growing fast, at a 300% clip. Kahoot! estimates its market opportunity at $20 billion. Softbank has invested $215 million in the company. Microsoft and Walt Disney are also investors.
While there's always a risk in buying cheap stocks, if your investment thesis is right, the upside is huge. I believe these companies are undervalued right now and will outperform the market going forward.