In late 2020, Peabody Energy (NYSE:BTU) was in trouble. The stock had dropped below $1 and the 138-year-old coal firm was at risk of getting delisted from its exchange.
What happened next was nothing short of stunning. The following January, shares began to rise.
At first, prices recovered to $3… Then $5… And then $9…
By the end of 2022, BTU stock was worth $26.42 per share.
In other words, every $10,000 invested in BTU would have become worth $264,200 in under two years!
Of course, not every penny stock returns 26X. Many of these low-priced stocks go straight to zero. Buying penny stocks blindly is also a proven way to lose money, as my quantitative research has shown.
But selectively choosing low-priced companies with wide “moats” around their business tilts the odds in investors’ favor. And as Peabody Energy shows, you only need one big winner to offset 25 stinkers.
In this article, we’ll explore five risky penny stocks with 5X upside potential. We’ll look at their industries, valuations and how each one has a strong franchise that could insulate investors from total loss.
What Makes a Penny Stock Risky?
Before we dive into the stocks, it’s essential to know the risks involved. So, what are they?
- Volatility. Penny stocks are known for their price swings; the average sub-$1 stock changes around 5% per day, according to data from Thomson Reuters.
- Low liquidity. Low share prices can also depress the total value traded, making it harder to enter a position profitably or sell without slippage.
- Limited financial data. Many penny stocks trade over-the-counter (OTC) with less stringent reporting rules. Even those on main exchanges often delay reporting.
- Susceptibility to manipulation and scams. Low prices and market capitalizations make penny stocks more susceptible to price manipulation and pump-and-dump schemes.
Nevertheless, history also tells us that well-capitalized companies with significant business “moats” offer strong downside protection. If shares fall, having valuable physical assets like Peabody Energy or a strong brand name can make the firm a tempting takeover target.
5 Penny Stocks With Explosive 5X Potential: Hanesbrands (HBI)
Hanesbrands (NYSE:HBI) is a leading global apparel company that designs, manufactures and markets inner and outerwear. Readers will know the firm for its Hanes, Champion and Playtex brands, among others. It’s a historically stable business that has generated positive net income in 19 of the past 20 years.
Still, Hanesbrands has recently seen its share prices collapse on sagging margins. Analysts expect Hanesbrands to earn only $113 million in 2023, a 67% decline from the prior year. HBI has now lost more than 70% of its value since mid-2021.
These issues can be traced directly back to Hanes’ cost structure. The company is around 80% vertically integrated, making raw cotton a significant expenditure. Rising commodity costs and stagnant apparel prices have thus squeezed its margins over the past 12 months. Analysts foresee Hanes generating 33.7% gross margins in 2023, its lowest level since a similar commodity squeeze in 2011-2012.
That’s why 2023 will likely mark the cyclical low point for Hanes’ margins. Cotton prices have now fallen from their $1.40 levels last year to around 80 cents today, its long-run average. Meanwhile, apparel prices have remained stable. And much like the commodity cycle a decade ago, these moves will eventually return Hanesbrands to business as usual. The same analysts expect gross margins to spring back to 36% in 2024 and for net profits to recover to 2022 levels.
Hanesbrands also has the advantage of owning high-performing brand names. Hanes, the underwear business, has a greater market share than its next two competitors combined and enjoys a pricing premium, according to analysts at MorningStar. HBI has also diligently shored up its balance sheet by cutting its dividend — a short-term loss for a longer-term gain. As high-priced cotton exits its supply chain, HBI stock could rise 5X from its current $4.80 level to over $20.
Latham Group (SWIM)
Latham Group (NASDAQ:SWIM) began life in 1956 as Pacific Pools, an innovator in its field. The company introduced the steel walk-in pool steps in 1966, all-resin inground pools in 1975 and 3D liner patterns that mimicked tile in 1994.
Latham Group has since become America’s largest designer and producer of in-ground residential pools. Its 2021 IPO was met with substantial optimism; shares would climb from $19 to well over $30.
But fears of a housing slowdown would send SWIM stock spiraling. Today, investors can pick up shares for under $2.50.
That’s far too low for a company like Latham. The firm has a strong distribution network built up over decades of strategic acquisitions. And its high gross margins are depressed by abnormally large overheads; any cost-cutting will have an outsized effect on its bottom line. Rival Pool Corp (NASDAQ:POOL) trades for 2X to 5X higher, depending on the valuation method.
That gives Latham Group 5X upside over the next several years. Shares could easily rise back to $12.50 as home spending picks back up. And as protection, its 450 distributor branch locations will make the company a tempting takeover target for rivals if share prices drop too low.
Ginkgo Bioworks (DNA)
My quantitative Profit & Protection system has often been skeptical of Ginkgo Bioworks (NASDAQ:DNA), a Boston-based biotech specializing in synthetic biology. The company’s history of losses and weak share momentum previously meant it earned a “C-” for quality and a “B” for momentum.
However, a recent stabilization in share prices now upgrades this penny stock to an “A+” for momentum, bringing its average score to an “A.”
That’s important because startups like Ginkgo Bioworks can fall a long way before making a recovery. The firm operates at a massive loss and probably won’t break even until at least 2027. Its shares have tumbled from their original $10 SPAC (special purpose acquisition company) price to about $1.30 today. There is no “intrinsic value” concept for a company like Ginkgo.
Still, these extreme price moves open the door to abnormal returns. The biotech carries 63 cents of cash per share and zero debt, meaning investors are “buying” Ginkgo Bioworks for only 67 cents per share.
The company is also a pioneer in synthetic biology, which uses microorganisms to produce chemicals and biologics. In 2020, Ginkgo partnered with vaccine maker Moderna (NASDAQ:MRNA) to deliver the nucleic acid vaccines needed for the Covid-19 pandemic. And many plant-based proteins use Ginkgo’s technology to coax yeast cells into making edible food. The startup’s intellectual property is likely worth in the billions of dollars.
Investors in DNA stock do face long odds of success; Ginkgo’s rapid cash burn rate means it will have to raise more capital this year. But if the firm succeeds in reaching profitability someday, its massive upside could outweigh any potential loss.
First Republic Bank (FRC)
The most controversial pick on this list is First Republic Bank (NYSE:FRC), a company that now borders on penny stock territory. Shares have fallen from $170 last August to around $13 today.
Experienced bank investors will immediately recognize the risks of buying this beaten-down bank. First Republic’s bank panic in mid-March means the firm might have liquidated a significant portion of its held-to-maturity portfolio, which had an unrecognized loss of $192 million as of Feb. 28. And if withdrawals were more severe than expected, the bank could have sold off its loan portfolio for consequential losses.
These write-downs have enormous knock-on effects on a bank’s balance sheet. In December 2022, First Republic held $212 billion in assets and $195 billion in liabilities. All else equal, a 9% haircut on assets would reduce that value to $193 billion, instantly wiping shareholders. Unsurprisingly, First Republic failed to make my initial list of 5 bank stocks to watch. FRC stock has since fallen another 60%.
However, that same 60% decline now gives First Republic shares a potential 5X upside. The company has a history of generating profits by servicing high-net-worth clients. Even if the bank has a diminished book value, it could earn its way back from fee and service income. These client relationships are valuable to any would-be acquirer, giving FRC meaningful downside protection. The same forces helped push Citigroup (NYSE:C) from $1 during the 2008 financial crisis to $50 today.
We won’t know for several months if First Republic’s assets are worth $212 billion… $200 billion… or $100 billion. But for speculators willing to take the risk, the abnormal upside could well outweigh a 100% loss.
Airline booking company Sabre (NASDAQ:SABR) rounds out this list of penny stocks with 5X potential
Sabre operates a three-way oligopoly of the world’s GDS (global distribution system) of airline and hotel booking. It’s a wide-moat industry that relies on network effects. Every time you or a travel agent search for a flight, the GDS system must query every airline in its system to find routes, availability and the right connection times. They must also “talk” with other GDS systems to find airline availability in other systems.
That makes it exceedingly difficult for new players to enter. Even Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google Flights and Expedia (NYSE:EXPE) rely on the three GDS companies. And Southwest Airlines (NYSE:LUV) remains the lone mainline U.S. carrier to avoid using the system. (It’s also why Southwest Airlines has become more prone to nationwide rebooking issues).
However, Sabre carries a significant debt load from its days as a private equity-owned firm, giving its shares abnormal volatility. Since 2021, the enterprise value of Sabre has fallen 33% on fears of a recession. That same loss has translated to a 72% decline in prices of its common stock.
Financial leverage, however, cuts both ways. As air travel returns to pre-pandemic levels, shares of Sabre should also recover to the $20 range. And no matter how low SABR stock falls, its valuable business makes it a takeover target by the same travel sites that have so far failed to muscle in on its territory.
Conclusion: The Risks and Rewards of Penny Stock Investing
Few investors agree on what a penny stock is. To some, it’s the price that matters. Some draw the line at sub-$20 stocks while others use $5 as a guideline.
To others, the exchange matters more. To these investors, penny stocks are any issue that trades over-the-counter (OTC).
Regardless of the definition, many investors agree that penny stocks are risky ventures that no “proper” investor should touch. You would be hard-pressed to find a financial advisor who wholeheartedly recommends a position in First Republic Bank; no one wants to recommend a “zero” to a client.
But institutional hesitation over penny stocks also makes them less efficient — a fact highlighted by their increased price volatility. And investors who are willing to see some of their holdings go to zero will benefit as others rise 5X or more.
On Penny Stocks and Low-Volume Stocks: With only the rarest exceptions, InvestorPlace does not publish commentary about companies that have a market cap of less than $100 million or trade less than 100,000 shares each day. That’s because these “penny stocks” are frequently the playground for scam artists and market manipulators. If we ever do publish commentary on a low-volume stock that may be affected by our commentary, we demand that InvestorPlace.com’s writers disclose this fact and warn readers of the risks.
Read More: Penny Stocks — How to Profit Without Getting Scammed
On the date of publication, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.