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About to Buy Penny Stocks? Look at These 3 Companies First

Travis Hoium, Matthew DiLallo, and Todd Campbell, The Motley Fool

For investors looking for big gains in the stock market, penny stocks can be enticing. But the low cost of a stock doesn't necessarily lead to big gains, and all too often, penny stocks just end up going lower. 

For investors looking for big gains, there's a lot to like about MGM Resorts International (NYSE: MGM), Invitae (NYSE: NVTA), and Denbury Resources (NYSE: DNR). Here's why three of our Motley Fool contributors think these are much better than penny stocks. 

Stack of coins and a piggy bank.

Image source: Getty Images.

A better gamble than penny stocks

Travis Hoium (MGM Resorts): Gambling on penny stocks can be disastrous financially, but gambling on gambling stocks can actually put the odds in your favor. MGM Resorts is one of the biggest gaming companies in the world and primarily operates in Macau and the Las Vegas Strip. That gives the company an enviable position of owning prime real estate and gaming licenses that provide a moat for the business. 

In the last few years, MGM Resorts has added MGM Cotai in Macau, MGM National Harbor near Washington, and MGM Springfield in Massachusetts to its portfolio, expanding an already sizable business. As these resorts ramp up, we'll likely see revenue continue to grow and EBITDA, a proxy for cash flow from resorts, will rise beyond the $2.6 billion generated over the past year. 

MGM Revenue (TTM) Chart

MGM Revenue (TTM) data by YCharts.

MGM Resorts has become a pretty good value for investors as well. The ratio of enterprise value (which adds debt and equity) to EBITDA is 12.2, which is reasonable given the company's opportunities to grow and its strong moat in a market like Macau, where gaming concessions are limited. If you want to gamble on a stock, MGM Resorts has much better odds than buying penny stocks right now. 

Get in on genetics

Todd Campbell (Invitae): Not only is Invitae's business on the cutting edge of revolutionizing healthcare, but it's also already delivering eye-popping growth to investors.

The company's laser focus on making genetic screening available to everyone is paying off. It's been able to reduce the cost of genetic screening by over 20% in the past year. And thanks to increasing insurance reimbursement, more patients and prospective parents can afford it than ever before.

In 2018, the company did 303,000 tests, up from 150,000 in 2017 and just 59,000 in 2016. Increasing demand and solid revenue (about $500 per test last year) translated into $148 million in revenue last year, up from $68 million in 2017, and just $25 million in 2016.

And it's important to note that Invitae's momentum is expected to continue. Management believes revenue can reach $220 million in 2019.

The big knock against Invitae is that it could be a while before Invitae rewards investors with net income. However, margins are improving and the addressable market is massive, so it may only be a matter of time before it turns a profit.

Invitae doesn't have this market all to itself. But I believe the potential reward outweighs the risk of it being out-innovated by its competition. Especially since it is reinvesting big money into research and development and has plenty of financial flexibility. Over 40% of its revenue was put back into research in 2018, and earlier this month, it announced plans to add $125 million in cash to the $132 million it had on the books on Dec. 31 via a public offering. Combine rapid growth with a solid balance sheet, and this becomes a top stock worth considering.

A high-upside oil stock

Matt DiLallo (Denbury Resources): The allure of penny stocks is that their low price point makes it seem as if it wouldn't take much for them to double in value. Unfortunately, most penny stocks are nothing but hype, which often leaves investors with losses after those pumping the stocks then dump them. That's why it's crucial for investors to look past the price and see if there is a viable business behind the stock ticker.

One better option for those looking for a low-dollar stock is oil producer Denbury Resources, which recently traded at less than $2 per share. The company is one of the leading enhanced oil recovery (EOR) producers, which is a process of coaxing oil out of older fields using carbon dioxide. Denbury has a viable business that produced enough cash to cover its $323 million of capital expenses with $81 million left over last year. And it had roughly 262 million barrels of oil equivalent remaining underground, which was worth about $4 billion at the end of last year, well below the company's current $3.3 billion enterprise value.

The issue with Denbury -- and the reason for its low-single-digit stock price -- is its $2.5 billion of outstanding debt, which is high for a company of its size. While it was able to pay off $281 million in debt last year, its leverage ratio remains well above the comfort zone of most oil companies. Denbury is working to address this issue by generating excess cash and merging with another oil company to improve its balance sheet and its growth prospects.

Denbury's elevated leverage ratio makes it highly sensitive to changes to oil prices, which is why its stock went on a wild ride last year. However, with a low-digit stock price, an upcoming merger, and leverage to oil prices, this high-risk, high-reward oil stock is a much better alternative to penny stocks. 

Something for everyone

MGM, Invitae, and Denbury don't have a lot in common, but they're well positioned for growth in attractive industries. Rather than buying penny stocks, these are great places to build your portfolio from. 

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Matthew DiLallo owns shares of Denbury Resources. Todd Campbell owns shares of Invitae. Travis Hoium has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.