Hidden Gems In The Penny Jar

By Will Ashworth | July 04, 2008 AAA

One of the riskiest investments you can find is the "penny stock". Penny stocks are generally defined by their price, usually under $5. They mostly trade over the counter, are extremely illiquid, and there is less information available on them. Basically, they are a big risk.

On the other hand, a "low-priced stock" shares a similar price with a penny stock, but that's usually where the similarity ends. Low-priced stocks often trade on major exchanges and have simply fallen on hard times, reducing in size from small cap to micro or nano cap. Low-priced stocks have more information available and have higher liquidity. It's a subtle but important difference when looking for hidden low-priced gems. In this article we'll highlight a few potential diamonds in the rough.

One Man's Trash...
Fidelity, one of the world's largest providers of mutual funds; has a $35 maximum for at least 80% of holdings in its Low-Priced Fund, although it's only a guideline. Kiplinger magazine considers low-priced stocks to be those trading between $3 and $7 with good products, low price to sales and price to book ratios whose stock is rising after an extended losing streak. Others consider micro caps, those companies with market capitalizations of less than $200 million, low-priced. A company with a market cap this large is generally not a tiny business despite the label. Definitions vary, but these criteria will give us a good starting point.

Company P/S P/B YTD price change (%)
Clearfield
(Nasdaq:CLFD)
0.70 1.17 18.81
Concord Camera
(Nasdaq:LENS)
0.28 0.46 10.44
Cyanotech
(Nasdaq:CYAN)
0.71 1.27 10.00
DRI Corp.
(Nasdaq:TBUS)
0.48 1.73 11.93
Easylink Services
(Nasdaq:ESIC)
1.16 1.72 14.01
Enterra Energy Trust
(NYSE:ENT)
1.36 1.19 279.31
ESS Technology
(Nasdaq:ESST)
0.89 1.31 21.81
Goldleaf Financial Solutions
(Nasdaq:GFSI)
0.67 0.79 36.48
LookSmart
(Nasdaq:LOOK)
1.15 1.70 28.21
Technology Solutions
(Nasdaq:TSCC)
0.50 1.27 77.94
Data as of June 27, 2008

DRI Corp. (Nasdaq:TBUS)
DRI Corp. is a North Carolina-based transportation communications company. It started in 1983 and went public in 1994. The company sells digital destination signs for buses and other modes of transportation, "Talking Bus" automatic voice announcement systems, GPS tracking and automatic vehicle monitoring. The company has two divisions: Digital Recorders Inc. and TwinVision of North America Inc.

North America accounts for 47% of its business with the remaining 53% coming from Sweden and other Scandinavian countries as well as Germany and France. Most sales are either to transportation authorities or to the manufacturers of buses and trains. It achieved record first quarter sales, up 41.9% year-over-year to $17 million. Operating income swung from a loss of $256,000 last year to a profit of $1.43 million. 2007 was the first year in the last five to make a profit. This year it looks to make it two in a row. Reasons for the drastic improvement include strong order trends, a bigger backlog and better gross margins. Its guidance in 2008 calls for between $68 million and $70 million in revenue and EPS of 14-17 cents. The N.Y. Times reported in May that public transit use this year is up anywhere from 5-15%, DRI is likely to benefit.

LookSmart Ltd. (Nasdaq:LOOK)
LookSmart helps advertisers and publishers achieve better results from their advertising. For publishers, it's all about monetizing the traffic that comes to its sites, and for advertisers, it's all about its return on investment from advertising. LookSmart has fallen a long way from $400 where it traded in early 2000. I highly doubt it can trade that high again; however, its first-quarter report was a good one.

Revenue increased 47% to $17.5 million year-over-year and 17% on a sequential basis from the fourth quarter in 2007. The loss from continuing operations was $200,000 compared to $2.5 million a year earlier. Other successes to mention include a 48% increase in revenue from its advertising network to $15.8 million; total paid clicks increased 62% to 152 million; it repurchased six million shares at an average cost of $3.47 per share and it beat revenue estimates by $2.5 million. It hasn't made much money in the last five years recording a profit only twice, last year and in 2003. After an almost breakeven performance in the first quarter, it's likely LookSmart can do it again in 2008.

Caution is Key
When looking for stocks with low prices it's sensible to buy only those stocks with decent financial stability, liquidity and timely financial reports. If you own a stock on a major exchange and it gets a notice of deficiency, you might want to think twice about continuing to own the stock. Nasdaq stocks must be non-compliant for 30 consecutive trading days before receiving a notice of deficiency. The company then has 90 days to ask for a hearing. That's 120 days before the exchange takes any action. If a company can't meet its requirements at that point, it's delisted. Once delisted, brokerage firms won't provide analyst coverage and many won't trade the stock. (For related reading, check out The Dirt On Delisting and Digging For Profitable Delistings.)

Bottom Line
It's important that one understand the difference between a "low-priced stock" and "penny stock". While by industry standards they can actually be one in the same, you'll generally find more risk in penny stocks. Low-priced stocks certainly contain risk, but they have more information available, greater liquidity, and higher reporting standards. By looking at this information I have found attractive stocks which should not be overlooked just because of their low price. With the right search and understanding you might find a very valuable gem at a bargain price.

For more on undervalued stock ideas, check out Finding Undiscovered Stocks.

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