This week, we wanted to take a look at low priced stocks. We are defining these as stocks that are priced at less than $5. We often focus on stocks that trade at low prices and there is a reason for that – these are the stocks that are most likely to record large gains.
The stock market provides an enormous amount of data. It also provides the opportunity to make large amounts of money. The opportunity provides a motive to study the data and there are detailed studies on almost every aspect of market behavior.
There are studies on how weather affects the stock market, how value affects the stock market returns, whether or not it’s better to buy recent winners or losers and what role the stock’s price plays in subsequent returns. It’s that last area of research we are applying this week.
Low Prices Carry High Potential Returns and High Risks
One study confirmed what many investors believe. Low priced stocks have higher average returns than high priced stocks. The results of that study are summarized in the table below. This shows the quarterly returns for stocks that traded between 2009 and 2013.
This table shows that lower priced stocks have the highest average return. The median return of lower priced stocks is also higher. The median price is the midpoint. One half of stocks had returns that were above the median and one half had returns that were below the median.
In the table, the average positive column shows the average gain for stocks that went up. The average negative shows the average decline for stocks that fell during the quarter. This is another data point to confirm that risk and return are higher for stocks trading at low prices.
But, the risks and returns for stocks trading at higher prices, those above $25, show the importance of stock selection. On average, the losers are almost as large as the gainers when looking at the absolute values. The risk return profile of low priced stocks seems to justify the risks in that price range.
The next table confirms that an investor pursuing big gains in an individual stock should focus on stocks trading below $5, or even $10. This table shows that 10.6% of the stocks trading below $5 doubled in value at some point during the quarter. However, 4% of those stocks fell at least 50% during the quarter.
Here, again, risks and rewards are important to consider. While the largest gain was 1,208% in just three months, the largest loss was 95%. Both values were in stocks priced below $5 when the quarter began. Note that there were big wins and big losses at all price points.
The large losses demonstrate the need for a risk management strategy, no matter which stock is bought. A stop loss is one way to manage risk. For example, if a stock drops by 50%, it could be sold.
Once a stock drops by 50%, an investor will need the stock to rise by 100% to get back to even. The data in the table above demonstrates that stocks rarely gain 100% or more in a short amount of time. This is especially true for stocks trading above $10.
Despite the risks, it can still be profitable to invest in stocks trading for less than $5. This is especially true when there are some steps taken to reduce the risks.
A Screen for Low Priced Stocks That Considers Risk
To find stocks that could deliver large gains we used FinViz.com to screen for stocks trading under $5 with high relative strength and earnings.
We used relative strength to avoid stocks that are declining. We screened for stocks that are within 10% of their 52-week high indicating they are in strong uptrends. To reduce risk, we required the company to have earnings over the past twelve months and an analyst forecast for earnings over the next twelve months.
The exact criteria we used are shown in the chart below.
The list includes seven stocks.
Lloyds Banking Group plc (NYSE: LYG) provides banking and financial services to both individual and business customers throughout the United Kingdom and internationally. The Insurance segment is world famous and provides home insurance, motor insurance, and life pension products. In addition, the company provides personal and business loans to its customers.
Mizuho Financial Group, Inc. (NYSE: MFG) offers banking, trust banking, securities, and other financial services in Japan, the Americas, Europe, and Asia/Oceania. It also offers consulting services, including asset management and asset succession; payroll services; and sells lottery tickets issued by prefectures and ordinance-designated cities.
Enduro Royalty Trust (NYSE: NDRO) is a Delaware statutory trust formed by Enduro Resource Partners to own a net profits interest representing the right to receive 80% of the net profits from the sale of oil and natural gas production from certain of Enduro Resource Partners’ properties in the States of Texas, Louisiana, and New Mexico.
Enduro is a royalty trust and may require separate tax forms when filing. This is always important to consider when making an investment decision because many investors prefer to avoid more complex tax forms.
Profire Energy, Inc. (Nasdaq: PFIE) is an oilfield technology company that provides burner- and chemical-management products and services for the oil and gas industry primarily in the United States and Canadian markets. The company sells and installs its systems in France, Italy, Ukraine, India, Nigeria, the Middle East, Australia, and Brazil.
Planet Payment, Inc. (Nasdaq: PLPM) provides international payment and transaction processing, and multi-currency processing services in the Asia Pacific region, the Americas, the Middle East, Africa, and Europe. The company offers payment processing services that enable the authorization and settlement of payment transactions by providing the connections between the merchant, its bank, and the card association; and online access to advanced reconciliation and reporting services, as well as localized language support to its customers.
Taseko Mines Limited (NYSE: TGB) is a mining company that acquires, develops, and operates mineral properties in Canada and the United States. The company explores for copper, molybdenum, gold, niobium, and silver deposits.
United Microelectronics Corporation (NYSE: UMC) provides semiconductor wafer foundry solutions to its customers. It provides circuit design, mask tooling, wafer fabrication, and assembly and testing services. The company also engages in the research, development, and manufacture of products in the solar energy and LED industries. It primarily serves fabless design companies and integrated device manufacturers. The company operates primarily in Taiwan, Singapore, China, Japan, Europe, and the United States.
Any, or all of these stocks, could provide large gains to investors. Any, or all of these stocks, could also suffer large declines and leave investors with losses. A portfolio of several of these stocks could reduce the risks of the strategy since diversification can reduce risks.
It is also important to have an exit strategy. The strategy could be to sell with a trailing stop. That means if the stock price ever declines by the amount of the trailing stop, it will be sold. A trailing stop of 25% or 50% could be used.
Once a position is closed, another could be opened. To find new trade candidates, the screen could be run at any time.
It’s also possible to use this strategy with a time stop. With that exit strategy, all positions would be closed at a predetermined time. The screen could be rerun at that point to find new buys. In this way, the strategy would always be searching for the next big winner and weeding out stocks that fail to deliver.