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 TrueBlue (NYSE: TBI).

Even the All-Stars in our 160,000-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, 51 stocks made the cut -- including our last topper, Arena Pharmaceuticals.

My favorite penny stock this week is International Coal Group (NYSE: ICO), an Appalachian coal miner that first appeared in this column almost exactly one year ago. Today's details:

Last time I covered International Coal, I wrote about how the Obama administration was cracking down on coal mining because of worries over water pollution. Traders shuddered at the thought of additional regulatory scrutiny, sending the stock sharply lower. It's been a multibagger since, validating this pitch from CAPS investor papa333 back then:

Once investors realize this coal stocks will recover, also as oil goes up ... and it will, coal will join in the run up. My favorite value pick and a long term hold. ... As I read the [last earnings] report, I saw only one negative, their loan issue, and that was worked out.

Whatever credit or loan issues plagued International Coal before, they're gone now. Earlier this month, the company sold $200 million in 9.25% senior secured notes.

The sale comes at an interesting time. In 2009, International Coal retired some $63 million in convertible debt by exchanging it for about 19 million shares. At the same time, cash from operations increased cash and short-term investments by almost $30 million. A better balance sheet means more flexibility in chasing growth opportunities. And that's important.

"If electric cars or plug-in hybrid cars become a popular alternative to gasoline cars, the demand for electricity will significantly increase," wrote CAPS investor KurtEng earlier this month. He concludes:

Nuclear will take too long to fully come online, wind resources are limited, natural gas is probably too expensive. No matter how much some pretend it won't happen, coal will become a more important energy source in the future. [International Coal] is one of many coal miners that I believe will benefit.

I'm inclined to agree, but does the price match the promise? Wall Street says no; researchers there think the stock is still cheap. The six analysts who cover the company expect 36% earnings growth per year over the next five years, about even with International Coal's 33 price-to-earnings ratio. To me, that seems more than fair.

Now it's your turn to weigh in. Would you buy International Coal 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.