Having joined this merry company back in 1996, I've been warning investors about the dangers of penny stocks (those trading for less than $5 per share) for more than a decade now. So imagine how my eyebrows rose as I read an article at TheStreet.com by James Altucher on the merits of investing in certain stocks priced at $5 or less.
He explained that he'd heard of a seemingly successful system involving buying and selling stocks trading on the New York Stock Exchange (NYSE) for less than $3 apiece. Part of the logic, presumably, is that since the NYSE has higher listing hurdles for companies, you'll find fewer shaky companies trading on it. (I recall, though, that Enron once traded on the NYSE, under the ticker ENE.) Another part of the system's logic is that these companies are beaten-down, and therefore stand a good chance of serving investors very well when (if!) they recover.
Altucher described a screen that seeks NYSE stocks trading under $5. As a compelling example, he offered the generally well-regarded contract manufacturer Solectron (NYSE:SLR):
"The company is sitting on $1.04 billion in cash and has $641 million in debt, so there is almost $400 million net cash in the bank. With a market cap of $3.1 billion and EBITDA of $334 million, Solectron's multiple over cash flows is just 8 times, putting it in buyout territory. SLR is also increasing earnings."
Let's try it
Intrigued, I thought I'd run a similar screen myself. But my search for S&P 500 companies trading for $5 or less yielded only two results: Solectron and Sanmina-SCI (NASDAQ:SANM). Increasing the maximum price to $6 per share only served to add Sun Microsystems (NASDAQ:SUNW) to the mix. When I expanded my search to all stocks trading on the NYSE, I got 57 hits, including companies such as Gateway (NYSE:GTW), Revlon (NYSE:REV), Safeguard Scientifics (NYSE:SFE), and Bally Total Fitness (NYSE:BFT).
If you're considering an approach like this, you'd better do a lot of research on any companies that pop up on these screens. As we've pointed out many times, and as Altucher also noted, "They're below $5 for a reason."
What to do
If you're in the market for beaten-down companies that stand a good chance of bouncing back, I think you'll find better candidates among bigger companies. If you want to screen for such outfits, consider screening for such variables as a minimum market cap of $500 million or $1 billion, and a P/E ratio below 18. (Note that P/E ratio ranges tend to vary by industry.) You might also look for a high return on equity or return on assets, as well as a high growth rate or a history of increasing dividends.
Finally, if you'd like some help finding promising turnaround candidates, I invite you to test-drive, for free, our Motley Fool Inside Value newsletter. Its recommendations have been beating the S&P 500 by a full 10 percentage points. A free trial (with no obligation) will give you full access to all past issues, so you can read about every recommendation in detail. Give it a whirl!
Longtime Fool contributor Selena Maranjian owns shares of no company mentioned herein. For more about Selena, view her bio and her profile. The Motley Fool is Fools writing for Fools.
