The Next Million-Dollar Penny Stock

Penny stocks can make you rich. Need proof? Every one of these multibaggers was once a penny stock:

Sources: Motley Fool CAPS, Yahoo! Finance.

The promise of outrageous returns has periodically made even the world's best stock pickers penny stock investors. Peter Lynch has enjoyed the stock market's super-cheap seats in the past, and still does on occasion. The Royce Low-Priced Stock fund has beaten the market for a decade by betting on stocks trading near or below $10 a share, including Tesco (Nasdaq: TESO).

Even the All-Stars in our 150,000-plus Motley Fool CAPS community take to penny stocks. More than a few have been richly rewarded.

Pennies from heaven
So why not invest in penny stocks? Well, the warning the SEC issued about them provides one excellent reason to steer clear. But what if we take the agency's definition literally, and limit our choices to stocks trading between $1.50 and $5 a share? And what if we further seek only four- and five-star stocks with a market cap between $250 million and $2 billion? Surely our CAPS screener would return some winners, right?

This week when I ran that screen, 52 stocks made the cut -- including our last topper, Conexant Systems.

My favorite penny stock this week is Continucare (NYSE: CNU), which provides outpatient services to Florida residents. The details:

The market for senior care is expanding. In a June 2009 report, BCC Research said $279.2 billion was spent in eldercare in 2008, and an estimated $316.9 billion last year. Health care is the fastest-growing subset of the market, expected to increase 9.1% annually to 2014, BCC projects.

Analysts see Continucare surfing the rising tide. According to Yahoo! Finance and its data providers, Wall Street expects the company to improve per-share earnings 20% a year over the next five. Balancing that against a 14.2 forward P/E ratio (current year) results in a 0.71 PEG ratio -- suggestive of a stock that's undervalued compared to forecasts.

Are the Street's forecasts fair, or historically relevant? I think so. According to data at Earnings.com, Continucare has marginally beaten the average analyst projection in every quarter but one going back through the fourth quarter of 2007. Three analysts have full-year expectations on the stock at present, and institutions were buying in December.

As Foolish colleague Rich Smith wrote at the time:

If you're wondering whether your eyes have deceived you -- they haven't. In a world where giants of health care like UnitedHealth (NYSE: UNH) have seen growth shrink to the single-digit-percent rate, while others like Coventry Health (NYSE: CVH) have seen profits steadily shrinking, Continucare is still growing. Even better, after a mid-decade hiccup, its profits have been steadily climbing at rates higher than its overall sales.

That's still true, and the balance sheet looks as strong as it's ever been. Continucare has no debt and $27 million in cash and short-term investments. Returns on capital and equity have been rising steadily since 2007, and are now positioned solidly in the double digits. These are the sorts of fundamentals that lead to higher returns, argues CAPS investor ross812 in this January pitch:

The fundamentals of this company are outstanding. ... Wall Street is calling for increased earnings over the next two years. The company recently made an acquisition of a profitable sleep clinic at a discount, which should pay off well with increased cash flow.

Now it's your turn to weigh in. Would you buy Continucare at today's prices? Let us know by signing up for CAPS today. It's 100% free to participate. You can also weigh in using the comments box below.