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5 High-Risk, High-Reward Stocks We're Watching

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Our Motley Fool contributors have these high-risk names on their radar, and perhaps you should, too.

Image source: Pictures of Money via Flickr Creative Commons.

This article was originally published on October 23rd, 2015 and was updated on March 9th, 2016 to reflect new information. 

While we Fools tend to fill our portfolios with companies on rock-solid financial footing in dominate competitive positions, we certainly recognize that it can be prudent to invest in riskier stocks every once in a while, as the gains that can be had when you buy into a winner can be extraordinary.

We asked our team of Motley Fool contributors to share stock ideas that hold the potential to produce multi-bagger returns, but come with a whole lot of risk. Read below to hear about a few companies on their radars that have them excited.

Matt Frankel: Investors who have extra money (read: money you're willing to potentially lose) and want to take a swing for a home run might consider Fannie Mae (FNMA 5.51%) or Freddie Mac (FMCC 3.64%)

Ever since receiving $187.4 billion in bailouts during the financial crisis, Fannie and Freddie have been in conservatorship. And shareholders -- including some big-name activist investors such as Bill Ackman -- are suing the government to try and change the arrangement. The case is currently in front of Judge Margaret Sweeney, who has made decisions in the case that seem to be more shareholder-friendly than other judges in the past.

The shareholders have valid points. Originally structured as a loan that could be paid back, the government unilaterally decided that it would collect all of Fannie and Freddie's profits as dividends -- hence, the bailout will never be repaid, and conservatorship continues indefinitely. As of this writing,  more than $245 billion has been paid back, or $58 billion more than the agencies received in the first place. 

Also, many of these investors took a chance and bought shares of Fannie and Freddie when both companies were left for dead. Now that they're profitable again, don't investors deserve some reward?

Let me be perfectly clear: I am not endorsing Fannie Mae or Freddie Mac as investments, and I think the most likely outcome is that shareholders will eventually get wiped out. However, Ackman's Pershing Square conducted a thorough analysis and found that the agencies' shares could be worth $23 or more if conservatorship ends and they are allowed to recapitalize. That's more than 10 times the current price, and I thoroughly believe the odds of shareholder success are significantly better than 10-to-1. So, if you're looking to put some of your extra cash in a "lottery ticket" stock, this could work for you.

Jordan Wathen: One of my riskier picks is an insurance company, Atlas Financial Holdings (AFH -0.08%). On one hand, it's everything you could want in a company. Its gross written premiums grew 98.9% year over year in the most recent quarter, or 49.8% if you exclude the impact of acquisitions. Given its fast growth and hefty profitability, that it trades at about 1.75 times book value and about 11 times last year's earnings makes it even more compelling.

But what underlies its growth is what makes it risky. Atlas Financial primarily sells property and casualty insurance to taxi operators and paratransit services. The industry is undergoing substantial change as Uber and Lyft usurp riders.

I'm not quite sure how to handicap the future for Atlas Financial. On one hand, its managers have proven to be excellent operators, keeping losses low and acquiring their fair share of the industry at a breakneck pace. On the other hand, a shift toward ride sharing and the consolidation of fleet services may make the competitive dynamics less attractive for insurers, which may lose pricing power as fleet sizes grow. In addition, more and more of its core customers are reporting that they expect their rates to flatten or decline compared to two years ago, when the majority were seeing solid single-digit price increases.

It's either a company that will prove to be a long-term compounder of investor wealth, or a highly valued insurer on the verge of a fundamental shift that will change its industry forever. For these reasons, Atlas Financial remains on my watchlist only, but I do think it's a company worthy of deeper study.

Dan Caplinger: One thing investors have learned over the past several months is that even the biggest, most important companies can be vulnerable to sharp market declines. That's been the case with Chinese online search giant Baidu (BIDU -1.03%), which saw its stock plunge as much as 60% in response to the pressures the Chinese stock market faced last summer.

When the Shanghai Composite and other Chinese stock benchmarks started to decline, bearish investors feared that even giants like Baidu would fall prey to slowing economic activity in the emerging market. Moreover, with many investors having accused Chinese technology stocks of being in a bubble reminiscent of the Internet boom of the late 1990s in the U.S., Baidu was a logical target for those who wanted to bet against Chinese stocks.

Yet Baidu has done a superlative job of fending off some tough competition from up-and-coming players in the Internet and mobile industry, and with the company having implemented a billion-dollar stock buyback program, investors can see that Baidu itself believes in its long-term prospects. The risks of China haven't gone away, but Baidu looks like it has a promising future ahead of it if it can retain its stranglehold over the Chinese Internet space.

Brian Feroldi: No other stocks reflect high-risk, high-reward investing like small-cap biotechnology companies. Given their enormous cash needs and long development cycles, investors in the space can earn huge returns if they buy into a winner ahead of time, but these companies often face poor odds of success, so investors need to proceed carefully.

One name I have my eye on is bluebird bio (BLUE 13.42%), a high-flying clinical-stage biotechnology company with a focus on gene therapy. Its potential treatment option involves extracting a patient's own cells, inserting a healthy gene directly into them, and then reintroducing them into the patient's body. If all goes well, the patient's genome is altered at the cellular level, which directly addresses the root cause of a genetic disease.

Currently, the company is in late-stage clinical trials with two different therapies: Lenti-D, which is designed to treat a rare hereditary neurological disorder known as childhood cerebral adrenoleukodystrophy, and LentiGlobin, which holds the potential to cure beta-thalassemia major and severe sickle cell disease. While both of these treatments hold huge potential, LentiGlobin in particular could be a blockbuster.

Of course, with any emerging treatment, there is plenty of risk that investors need to be aware of. The standard risks of getting the therapy through clinical trials and past regulators are here, but since these treatments are likely to be expensive, there is also the huge task of getting payers on board, as well as helping to educate and train providers on how to properly utilize this complicated treatment.

The risks here are certainly huge, which is why bluebird remains a radar stock for me at the moment. But if the company continues to show strong clinical outcomes, it may be a stock worth initiating a small position in. 

Cheryl Swanson: Cempra (MLNT) is a stock that epitomizes the gut-wrenching risk of investing in clinical-stage biotechs. Safety concerns on Cempra's next-generation antibiotic in its phase 3 trial spooked investors and sent the stock off a cliff. But while Cempra lost almost a third of its value in one day, its potential reward could also be sky-high as pessimism recedes. 

Why the ugly drop? The company said solithromycin showed slightly increased levels of liver enzymes across treatment arms, as well as some infusion-associated heart-rate elevations. While that's nothing to be taken lightly, prior-generation macrolides, including Sanofi's telithromycin and Pfizer's azithromycin, triggered similar concerns. Telithromycin is associated with liver toxicity, and azithromycin with heart risk.

The good news is that the FDA is keen to approve next-generation antibiotics. The rise of dangerous, antibiotic-resistant infections is a major concern, and solithromycin clearly met the FDA's primary endpoint. Assuming approval, expect this drug to be a blockbuster. Solithromycin treats community-acquired bacterial pneumonia (CABP), which is the leading cause of death due to infection, with about 5-10 million annual cases in the United States.  

In addition, Cempra's investment thesis is wider than solithromycin. Taksta, its other late-stage drug, earned a Qualified Infectious Disease Status (QDIP) on September 18. That gives Taksta fast-track status and an additional five years of market exclusivity, something solithromycin also has, assuming it's approved.

Still, Cempra will have a tough time marketing these drugs if it can't nail down a partnership with a big-pharma player, or if its portfolio of innovative antibiotics doesn't tempt a lucrative acquisition.

Brian Feroldi owns shares of Baidu. Cheryl Swanson has no position in any stocks mentioned. Dan Caplinger has no position in any stocks mentioned. Jordan Wathen has no position in any stocks mentioned. Matthew Frankel has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Baidu. The Motley Fool recommends Bluebird Bio. 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.

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Stocks Mentioned

Baidu, Inc. Stock Quote
Baidu, Inc.
$136.40 (-1.03%) $-1.42
Melinta Therapeutics, Inc. Stock Quote
Melinta Therapeutics, Inc.
Federal National Mortgage Association Stock Quote
Federal National Mortgage Association
$0.65 (5.51%) $0.03
Federal Home Loan Mortgage Corporation Stock Quote
Federal Home Loan Mortgage Corporation
$0.63 (3.64%) $0.02
bluebird bio, Inc. Stock Quote
bluebird bio, Inc.
$6.34 (13.42%) $0.75
Atlas Financial Holdings, Inc. Stock Quote
Atlas Financial Holdings, Inc.
$0.13 (-0.08%) $0.00

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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