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).

#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.

#4. Threshold Pharmaceuticals Inc. (NASDAQ:THLD)

– Hedge Funds with Long Positions (as of June 30): 12

– Value of Hedge Funds’ Holdings (as of June 30): $8.38 Million

Threshold Pharmaceuticals Inc. (NASDAQ:THLD) received some love from the hedge fund industry monitored by Insider Monkey during the second quarter, as the number of funds invested in the company rose to 12 from nine quarter-on-quarter. Similarly, the aggregate value of those funds’ equity investments in Threshold Pharmaceuticals jumped by 62% quarter-over-quarter to $8.38 million, partially due to a 38% spike in the value of Threshold’s shares. The 12 asset managers hoarded up nearly 19% of the company’s common stock. The clinical-stage biopharmaceutical company, which focuses on developing therapeutic and diagnostic agents that selectively target tumor cells for the treatment of patients suffering from cancer, has seen the value of its stock skyrocket by 154% since the start of the year. Threshold Pharmaceuticals is currently evaluating two therapeutic product candidates based on hypoxia-activated prodrug technology: evofosfamide and tarloxotinib. James E. Flynn’s Deerfield Management acquired a new stake of 2.58 million shares in Threshold Pharmaceuticals Inc. (NASDAQ:THLD) during the April-June quarter.

#3. Bonanza Creek Energy Inc. (NYSE:BCEI)

– Hedge Funds with Long Positions (as of June 30): 12

– Value of Hedge Funds’ Holdings (as of June 30): $68.91 Million

There were 12 asset managers from our system with long positions in Bonanza Creek Energy Inc. (NYSE:BCEI) both at the end of the first and second quarter of 2016. Nonetheless, the overall value of those positions spiked to $68.91 million from a mere $11.82 million, partly due to a 26% increase in the value of Bonanza shares. Therefore, some hedge funds massively increased their exposure to the company during the June quarter. More importantly, the 12 hedge funds accumulated around 69% of Bonanza Creek Energy’s overall number of outstanding shares. The liquidity outlook of the Denver-based oil explorer has deteriorated significantly since the first quarter of 2016 due to a borrowing base reduction, inability to sell assets given the unfavorable market conditions, continued depressed commodity prices, as well as inability to access the debt and capital markets. Bonanza Creek Energy has lost 75% of its market value since the beginning of the year. In early August, the company announced that it would skip an interest payment due on $300 million of senior unsecured notes, but the company eventually decided to pay interest on those notes at the end of August. Ken Griffin’s Citadel Advisors LLC reported ownership of 623,048 shares of Bonanza Creek Energy Inc. (NYSE:BCEI) in its 13F for the end of the second quarter.

#2. Quantum Corp (NYSE:QTM)

– Hedge Funds with Long Positions (as of June 30): 15

– Value of Hedge Funds’ Holdings (as of June 30): $26.09 Million

The number of hedge fund vehicles invested in Quantum Corp (NYSE:QTM) increased to 15 from 13 during the second quarter, whereas the aggregate value of their stakes in the company decreased by 29% quarter-on-quarter to $26.09 million. The 29%-decrease was mainly attributable to a decline of 31% in the value of Quantum shares. The shares of the expert in scale-out storage, archive and data protection are 18% in the red thus far in 2016. The company reported total revenue of $116.3 million for the fiscal quarter of fiscal 2017 that ended June 30, an increase of $5.4 million year-over-year. The increase in Quantum’s top line was mainly driven by increased revenue from disk backup systems, devices and media and scale-out storage solutions, partly offset by lower revenue from service and royalty. Jeffrey Smith’s Starboard Value LP had a whopping 19.97 million shares of Quantum Corp (NYSE:QTM) in its portfolio at the end of the June quarter.

#1. Cumulus Media Inc. (NASDAQ:CMLS)

– Hedge Funds with Long Positions (as of June 30): 15

– Value of Hedge Funds’ Holdings (as of June 30): $29.36 Million

Cumulus Media Inc. (NASDAQ:CMLS) was the favorite penny stock among the hedge funds followed by Insider Monkey at the end of the second quarter. The number of smart money investors with stakes in the company increased to 15 from 13 quarter-on-quarter, while the overall value of those stakes rose by 78% quarter-over-quarter to $29.36 million despite a drop of 33% in the value of Cumulus Media’s shares. The 15 hedge funds stockpiled 40% of the company’s outstanding shares. Cumulus Media, a leading player in the radio broadcasting industry, has seen its shares advance by 9% so far in 2016. The Atlanta-based radio giant reported net revenue of $287.2 million for the second quarter, down from $299.3 million recorded in the same period of the prior year. The decrease reflects lower broadcasting advertising, digital advertising and license fees, partly offset by higher political advertising revenue. James Dondero’s Highland Capital Management owns 5.80 million shares of Cumulus Media Inc. (NASDAQ:CMLS) as of the end of the April-to-June period.

Disclosure: None