Making Cents in Penny Stocks

The occasional shower of pennies from heaven might do our bank accounts some good, but we Fools can't say the same for penny stocks. The world of penny stocks is often full of manipulation and deceit, making it harder for investors to separate its few good offerings from the multitude best ignored.

Although some investors think cheaper stocks have a greater chance to appreciate, those stocks may be cheap for a reason. Indeed, a $20 stock may have better chances of gaining value than a $0.20 one.

Still, many investors dabble at the low end of the stock-price spectrum. At Motley Fool CAPS, we award the title of "Pennies" to investors who rate stocks trading in the single digits more than half the time. Believe it or not, you'll find some of the best CAPS All-Stars among those players.

Pinching pennies
This week, we'll look at some of the low-priced investments these All-Stars have praised. If the best investors regularly scanning this end of the market have singled out these companies, we might want to turn our umbrellas upside-down -- or run for cover!

Here's the latest list of low-priced stocks with All-Star support:

As we delve into the low-priced "pennies," we find that most of the companies listed above are generally well-liked by the 97,000-person CAPS community, as the majority are rated at four stars.

Coal to Newcastle
The markets have not been kind to Newcastle, which has plunged more than 60% over the past year. Yet in recent weeks, the real estate investment trust (REIT) has done much to improve its liquidity, although it is still penalized by the market, as are many investments that need to access the credit markets these days.

The company increased its cash on hand to about $120 million (up from $29 million at year's end) while also reducing recourse borrowings from $1.8 billion to just more than $900 million.

And last month it slashed its dividend 65%, down to $0.25 per share, in an effort to keep itself liquid and have money on hand for opportunistic buys. It was not necessarily unexpected, since management indicated during its previous earnings call that it would be looking at the dividend.

Although analysts have downgraded the REIT, some investors see the opportunity here for a bottom, thinking that the baby was thrown out with the bathwater. Back in January, top-rated CAPS All-Star UncommonSense anticipated the dividend cut, but still found NCT to be a viable investment.

Newcastle Investment will continue to pay a dividend in 2008, even if they cut it, it will still be far above average.

According to GAAP, NCT must report the value of their assets mark-to-market, which means they have to value their assets at what they could sell them right now for. The credit crisis has precipitated the decline in value of these assets despite the fact the default rate is still less than 1%.

... In five years from now, when the country has more than recovered from the credit crisis and the housing slump, those who had the [guts] to buy these things on the cheap will be the ones who are laughing their way to the bank.

Not everyone is sold, of course. All-Star TheGarcipian finds Newcastle looking as if it will sink into the morass.

How many ways can you spell "Fire Sale"? Let me count the ways. (1) a debt-to-equity ratio of 16.5-to-1?! (2) the company nearing book value ($5.60/shr); (3) negative RoA, RoE, cash flow, Profit Margin and Quarterly Revenue Growth (yikes!); (4) and an outstanding 25% of stock is now shorted. Jiminy Crickets! To borrow a quote from a favorite Monty Python movie, it looks like the Newcastle is about to burn down to the ground, fall over, and then sink into the swamp ...

Make some change
What do you think? Should we fill up the change jar with these penny stocks, or ignore 'em like a coin in the street? Consult our free Motley Fool CAPS investor-intelligence community, where your two cents count as much as anyone else's.