Who doesn't like a great multibagger return? It feels fantastic to make a killing on a stock, and hitting a home run can be a great ego boost and fill your pocket to boot. But to get those great returns, investors often have to take on very high risk, sometimes gambling on the uncertain future of a penny stock.
If the company can navigate around those risks, big returns can accrue to investors who bought when few others would. On the other hand, if the company can't get past its problems, its priced-for-death valuation was simply accurate.
Below are seven companies whose stocks have attracted enormous interest from investors, perhaps because many of the shares trade hands at just pennies a share and seem to offer stock market gamblers the chance for instant riches. But beware of these seemingly get-rich-quick schemes that might leave you as a broke as bar-bar-lemon on a slot machine:
Trading at just $3.41, shares of YRC Worldwide can be had for the price of a cup of coffee. But the coffee might last longer. The company just finished the 19th renegotiation of its bank loans, and the effective result is that whatever cash comes in is likely to head straight to the banks' pocketbooks. And in fact, over the past four quarters, the company has paid more in interest ($173 million) than its current market cap ($161 million). With its highly leveraged balance sheet, YRC Worldwide would offer multibagger returns, if it could actually survive and thrive.
The past two years have been kind to Sirius, without a doubt, after the company was almost permanently silenced. The quintessential penny stock, shares of the satellite-radio purveyor dropped below $0.10 in February 2009 and have come storming back to $1.61 now -- nice returns if you could get 'em. In 2009, the company finally generated an operating profit, which has nearly doubled in the past four quarters. In fact, over each of the past four quarters, the company has registered a net profit, a first for the debt-heavy company.
But while the company has made some good operational moves -- such as a broadcasting deal with soccer's Manchester United and a new five-year lock-up with Howard Stern -- its valuation at 11.7 times enterprise value/EBITDA is too dear for me.
If any stock investment seemed like it was rolling the dice, it would have to be investing in a potential gold mine as gold prices continue to reach multiyear highs. Unfortunately for shareholders, Taseko recently lost its bid for Canadian regulatory approval of its Prosperity gold and copper mine, making the company effectively a pure play on copper. Shares initially dropped 30% on the news, but the company may have another shot at opening the mine, by revising the mine plan to address the key concerns of regulators. Given the company's massive drop on the negative news, I can only expect a huge gain if the mine were to be approved -- exactly the type of binary bet that gambling investors love.
Probably the best managed companies on this list, Chimera and Annaly are different beasts from other denizens here. These mortgage real estate investment trusts (REITs) pay gaudy dividends above 14%, which is the big draw, but they won't be able to do so indefinitely. They make money on the spread between short- and long-term rates, so as rates creep higher (as they inevitably will), Chimera and Annaly will be forced to reduce their payouts. Just look at what Annaly did during the latest recession. Many investors think they can get out before the crash, but you never know it's a crash until after it happens.
Nothing says gambling like a cash-burning, small-cap biotech, and Cell Therapeutics fits the bill perfectly, with a $330 million market cap. Last April, the Food and Drug Administration rejected the company's application for its drug Pixuvir as a treatment for non-Hodgkin's lymphoma. The FDA was concerned that trials did not show the effectiveness of the drug, and the agency asked the developer to conduct another clinical trial. Cell Therapeutics appealed the decision and is awaiting a ruling on its appeal during the first quarter of 2011. But the company is also preparing a new drug trial, which would be used as part of new application if the FDA does not change its mind.
Shares are well off their levels of a few years ago, and it looks like even a modest victory would send shares soaring. On the other hand, the company has burned about $70 million in cash in the past 12 months and had just $17 million as of its latest report. So the company needs cash.
Call American Capital the phoenix of the financial crisis. The stock tripled in 2010 but is still down more than 80% from its highs in 2007. And you can see those moves in its volatility -- which is twice that of the broader market. The company has restructured and paid down $3 billion in debt in the past four years or so, but it still has high leverage, meaning it will probably fail spectacularly or rise meteorica lly.
Foolish bottom line
Some of the stocks here will go on to greatness and some will probably flame out. But just because shares trade for pennies doesn't mean they're bound to go up (or down, for that matter). Instead of betting the farm on these gambles, consider taking a longer-term approach and buying high-quality companies that are poised to prosper whatever the economic climate.
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Jim Royal, Ph.D., owns shares of American Capital and Annaly. The Fool owns shares of Annaly. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.