Here at the Fool, we don't tend to put much trust in penny stocks. A tiny share price may sound inviting -- even safe -- but it actually leaves the stock open to increased volatility and more risk.

Moreover, penny stocks often go hand in hand with microscopic market caps, a condition that comes with its own set of risks, rewards, and complications. All told, a well-designed campaign of spam emails and/or fanatical message-board postings could pump a hapless penny stock to high heavens -- and then leave it to implode again. Who's left bleeding cash in the ruins of schemes like that? Individual investors who took a flyer on a rumor or a whim.

It's easy to see why the major stock exchanges will kick a company out if it can't meet some basic minimum pricing limits. Reverse splits also make sense for much the same reasons, even if they rarely work out.

Rules are made to be broken!
That being said, low share prices are not necessarily a death sentence. Some small-cap, low-priced stocks belong to well-run businesses that have fallen on hard times for some reason. There are many decent companies in this category, and some that are truly excellent. When their temporary hardship passes -- and we've seen hardship hitting everyone from Citigroup (NYSE:C) to Sirius XM Radio (NASDAQ:SIRI) lately -- the true survivors should be poised for massive gains, starting from rock-bottom prices.

So why not ask your fellow investors for some help? Using our CAPS screener, you can pinpoint stocks with low, low prices yet reasonable market caps that have impressed our CAPS members throughout this recession.

If you're playing along at home, here's how to duplicate my results before fine-tuning the screen to suit your own preferences:

  • Demand a market cap of at least $500 million, to weed out the worst of the easily manipulated stocks.
  • Ask for a share price below $5, which happens to be the cutoff point where the Nasdaq and NYSE start sending letters to a company's management.
  • Make sure that the stock is rated at least four CAPS stars out of five today -- and that it was just as respectable six months ago.

Using these criteria, I get a short list of 15 results. Here's the cream of that crop:

Company

Current Share Price

Current Market Cap

CAPS Stars Today

CAPS Stars March 3, 2009

United Microelectronics (NYSE:UMC)

$3.32

$7.32 billion

****

4

Level 3 Communications (NASDAQ:LVLT)

$1.14

$1.9 billion

****

4

Himax Technologies (NASDAQ:HIMX)

$3.43

$652 million

*****

5

Northgate Minerals (AMEX:NXG)

$2.48

$634 million

*****

5

Mueller Water Products (NYSE:MWA)

$4.50

$524 million

*****

5

Data from Motley Fool CAPS as of Sept. 3.

This is not a list of outright recommendations, of course. Screening is useful for stripping the market down from thousands of stocks that may or may not appeal to your investing sensibilities and creating a short list of research-worthy starting points. And a lot of pertinent information can be found just a couple of clicks away from your list of screen results.

Examples
You will find that United Microelectronics is poking at 52-week highs, having crushed the market with a 52% one-year boost while the S&P 500 benchmark took a 22% haircut. This third-party manufacturer of semiconductor chips is well on its way back from even lower prices -- and our CAPS members see even more gains ahead. All-star player BengalPennyCAPS, for example, notes that UMC has "next to no debt, better margins than the industry as a whole, decent ratios otherwise, and improved relations with China (at present) can't hurt the cause any."

Telecom operator Level 3 has not started its recovery quite yet, but produced $446 million of operating cash flow over the last 12 months by selling high-speed voice and data connections to a bandwidth-hungry world. CAPS player Vikingzskillz tags Level 3 as a 10-bagger in 3 years, based on rising demand for its communications infrastructure.

What's next?
Blue-chip penny stocks do exist if you only look hard enough. Once you locate the right ones, their depressed share prices give you the perfect launching pad for huge profits. It's not an easy game to play, and nobody can guarantee your success. But as long as you pick your poison carefully, the gains should outweigh the risks with market-beating results. And if you would like even more guidance in the rocky waters of small-cap investing, the Motley Fool Hidden Gems team is here to help. A 30-day trial pass is 100% risk-free and won't cost you a penny.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. You can check out Anders' holdings or a concise bio if you like. The Motley Fool is investors writing for investors.