Hedge Funds Think These Penny Stocks Are Poised to Explode

New and naïve investors usually fall under the illusion that investing in penny stocks represents a quick way to earn extremely high trading profits. But nothing could be further from the truth. Indeed, such stocks are considered to be highly risky and speculative because of their lack of liquidity, large ask-bid spreads, limited analyst coverage, as well as limited disclosure.

It appears that the primary reason most retail investors seem to be attracted to investing in penny stocks is because the share prices of these companies tend to fluctuate quite madly in a short period of time. For instance, the share price of a low-priced stock may increase from $0.25 to $1.50 within a five-day period, so the naïve type of investors may think they could have earned $6,000 by investing a mere $1,000. Even if you buy 4,000 shares at $0.25 and the share price goes to $1.50, you might have a hard time unloading your position because of a limited number of buyers. Despite that, there might be some bargains in the penny stock space, so Insider Monkey would like to present a list of five penny stocks favored by the hedge fund firms followed by our team.

Through extensive research, we determined that imitating some of the picks of hedge funds and other institutional investors can help generate market-beating returns over the long run. The key is to focus on the small-cap picks of these investors, since they are usually less followed by the broader market and are less price-efficient. Our backtests that covered the period between 1999 and 2012, showed that following the 15 most popular small-caps among hedge funds can help a retail investor beat the market by an average of 95 basis points per month (see more details here).

Jirsak/Shutterstock.com

Jirsak/Shutterstock.com

#5. ITT Educational Services Inc. (NYSE:ESI)

– Hedge Funds with Long Positions (as of June 30): 11

– Value of Hedge Funds’ Holdings (as of June 30): $9.66 Million

There were 11 hedge funds followed by Insider Monkey with long positions in ITT Educational Services Inc. (NYSE:ESI) at the end of the second quarter, down from 14 recorded three months earlier. Meanwhile, the overall value of their positions shrank by 46% quarter-over-quarter to $9.66 million, primarily reflecting a 37% decline in the value of the company’s shares. The 11 hedge funds amassed 21% of the company’s total number of outstanding shares on June 30. The proprietary provider of postsecondary degree programs in the United States has seen its market capitalization plunge by 90% since the beginning of the year. Similar to other for-profit college operators, ITT Educational Services has faced federal and state investigations around its recruiting and accounting practices. Just recently, the company announced that it was permanently closing all its campuses across the nation, after the U.S. Educational Department banned ITT from enrolling new students who use federal financial aid. Jim Simons’ Renaissance Technologies LLC owned 336,800 shares of ITT Educational Services Inc. (NYSE:ESI) at the end of June.

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