Making Cents in Penny Stocks

The occasional shower of pennies from heaven might do our bank accounts some good. Alas, Fools can't say the same for penny stocks. They're often subject to manipulation and deceit, making it harder for investors to separate the few good offerings from the multitude best ignored.

Still, many investors enjoy dabbling at the low end of the stock-price spectrum. At Motley Fool CAPS, a "penny stock" is any stock trading under $10, and you'll find some of the best CAPS All-Stars regularly seeking out winning investments there. We identify them with a penny icon.

Pinching pennies
This week, we'll look at some of the low-priced investments these All-Stars have praised. If the best investors regularly scanning this end of the market have singled out these companies, we might want to turn our umbrellas upside-down -- or run for cover!

Here are three low-priced stocks enjoying All-Star support:

^Price when the outperform call was made.

These three companies may be low-priced, but that isn't necessarily enough to suggest they'll have an easier time recording big gains. Low-priced stocks are often low-priced for a reason. We have to check and see what their catalysts for growth might be before diving in to the shallow end of the stock pool.

Your two cents' worth
Rumors are swirling that the Treasury Department is poised to unleash an "August surprise" in time for November's elections, a massive homeowner bailout that forgives a portion of the mortgage debt owed by those of us who are underwater on our loans. With some 20% of mortgage holders owing more than their house is worth with a negative equity of around $800 billion, it would amount to a gigantic giveaway. Keep an eye on Aug. 17, when Treasury discusses the future of Fannie Mae and Freddie Mac.

While homeowners would obviously benefit, banks and REITs like Chimera Investment, Annaly Capital Management (NYSE: NLY), and RAIT Financial Trust (NYSE: RAS) would come out ahead, too. Their balance sheets have been wrecked by having to write down their underperforming assets, but by transferring the damage to Fannie and Freddie (er, the taxpayer) -- which have been given an unlimited blank check from the government -- it becomes an instantaneous gift to the financial community, too. Of course, the damage it will do to our country's financial future is incalculable.

However, most investors looking at Chimera right now eyeball its juicy dividend yielding 17% annually and, like CAPS member clm5567, figure its beaten-down price makes a good entry point. CAPS investor DadofTwinsand1 concurs, but says Chimera is able to support its dividend unlike some other troubled REITs:

The dividend is easily supported by the earnings stream. The yield will lead to value investors adding it to their portfolio.

A short circuit
"Find a need and fill it" is a hallmark of business opportunity. In China, while basic materials and housing grab a lot of the headlines, the real need is for education. The country spends less than 2% of its GDP on education, though individual families can spend upward of 10% of their earnings on it, with a good portion going toward test prep.

Taking a page from industry leader New Oriental Education & Technology Group (NYSE: EDU), China Education Alliance believes there is sufficient demand to support the growing field of supplemental education services and training. A number of companies are attacking the opportunity.

As China Education is set to report earnings later this week, perhaps it's worth noting that New Oriental's results last month showed profits doubling from the year-ago period, even though they were down sequentially. Guidance of 25% earnings growth this year was in line with what analysts were anticipating, albeit New Oriental says it has aggressive expansion plans.

While CAPS member Oriented likes the potential in the sector, he's not sure China Education can make it to the head of the class:

There is lots of potential for growth in the online education sector. Don't know if this company can get its act together, capture the growth, and get unstuck from the around the $4/share price range or not.

Lack of communication
Not that the Fool pays much attention to technical analysis, but every so often a stock indicates it's a good buy according to such metrics. When that lines up with a fundamental analysis that suggests the business is sound and poised for growth, well, maybe investors ought to take a closer look.

Frontier Communications would seem to be one such case for the technical books. There are lots of chart squiggles that say it's a buy, but from a Fool's perspective it's the returns on equity and competitive advantages that say this is one for your portfolio. Despite competition from CenturyLink (NYSE: CTL), and even with the stock up more than 20% from last year's levels, you'd still be buying in at an undervalued price.

CAPS investor RonRea says look ahead to the future and it's easy to believe substantial growth lies ahead:

Future growth in this sector will come in small towns and rural areas which are proportionally underserved at present. Invest for a five year horizon.

Penny for your thoughts
Should we fill up the change jar with these penny stocks, or ignore 'em like a discarded coin on the street? It pays to start your own research on these stocks on Motley Fool CAPS. Read a company's financial reports, scrutinize key data and charts, and examine the comments your fellow investors have made -- all from a stock's CAPS page. Consult our free CAPS investor-intelligence community, where your two cents count as much as anyone else's.