Is Renren the Perfect Penny Stock?

Low-priced stocks are often low-priced for a reason: they have significant problems to overcome. Yet for those that have fixed their problems, they may be ready to take off to the next level.

At Motley Fool CAPS, the 180,000-member investor community where informed opinion is transformed into ratings from one to five stars, a "penny stock" is any stock trading under $10, and you'll find some of the best CAPS All-Stars regularly seeking out winning single-digit investments. We identify them with a penny icon, and by pairing up their opinions with companies trading for pennies on the dollar, relatively speaking, we may end up with more than just chump change.

Of course, just because a stock is low-priced isn't necessarily enough to suggest it will have an easier time recording big gains. Low-priced stocks are often low-priced for a reason. But this week we look at Chinese social network leader Renren (RENN), whose shares have lost more than 85% of the value they achieved during its May 2011 IPO and today trade at just over $3.50 a share as the company tries to regain relevance.

Renren snapshot

Source: FinViz.com. N/A = not applicable; Renren does not pay a dividend.

More than me-too
The more Renren seeks to break out of the mold of just being a Chinese version of Facebook (META -0.52%), the more it cements itself as being just that. It's latest initiatives run toward e-commerce and gaming, with its CEO believing the two will become "the mainstay of social networks," and he's pushing his company more in that direction.

Facebook itself is reliant upon games, with social-gaming specialist Zynga (ZNGA) accounting for 14% of its revenue over the first six months of 2012, its single largest customer. And with some 1 billion users, it's seeking to better monetize that base. Its credits currency unveiled last year is an attempt to unlock the potential for mobile commerce and it recently started allowing businesses to promote specific posts to their fans for a price.

Despite the lack of competition from its larger rival (Renren is protected from Facebook by the Great Firewall of China), Renren still has plenty of competition from microblogger sites that have proven just as popular with the masses. SINA's (SINA) Weibo and Tencent have been so popular they've attracted more than their share of attention from government regulators seeking to silence critics. That could be one of the big hurdles Renren itself has to surmount to gain a larger critical mass, even as it acknowledges Weibo limits its growth potential.

An all-you-can-eat buffet
The country's demographics make it tempting to think Renren can capture the same growth trajectory that Facebook has. The government-run China Internet Network Information Center crossed the half-billion-users mark last year, and it's estimated they'll hit 620 million users by the end of 2012. Renren reports its number of active users stood at 162 million at the end of June, up from 154 million in March, and monthly unique login users jumped 31%. So the potential for growth is there. Net revenue jumped 47.5% to $45 million, but recorded losses of $25 million because its costs are accelerating at a pace far in excess of its revenue growth.

If Renren is going to morph into a game developer, then that's going to be a very different business model than what investors were originally buying into, and it's going to put them up against some hefty competition like NetEase.com (NASDAQ: NTES). Already sporting sky-high valuations even though it trades for just a few dollars a share and offering up the possibility for only meager earnings growth, I think investors will be put off by the change.

Every day is Christmas
Some analysts still push the notion that as goes Facebook, so goes Renren, but I've argued against investors behaving like lemmings. The stock trades on its own merits, which have been found lacking. I've had a long-running underperform rating on CAPS and I'll be maintaining that rating. The stock has lost three-quarters of its value since I weighed in, compared to an 8% rise in the S&P 500. But you can tell me by commenting below whether you think this new business model will improve Renren's situation and allow it to break away from walking in lockstep with Facebook.