Pandora Media Inc (P) and Zynga Inc (ZNGA) Among Hedge Funds’ Favorite Penny Stocks

Investing in penny stocks is a risky endeavor, but it can also be highly profitable if you pick the right stocks. Many penny stocks cost below $1.0 per share and are listed outside the major market exchanges. In addition, they usually trade over-the-counter through the OTC Bulletin Board and pink sheets. Due to the nature of the exchanges that the stocks are listed on, which are much less regulated and allow companies to not disclose all information and most sources that cover these companies are not always truthful. This is why many penny stocks are considered speculative and high-risk investments.

However, there are companies whose stocks are trading below $5 per share (which the Wall Street considers as penny stocks), and which can result in very substantial returns. There are many penny stocks that are trading on big exchanges like Nasdaq and NYSE, which have to comply with regulations, register with the Securities and Exchange Commission and disclose their complete financial results in 10-Q and 10-K reports. Often these are small but reliable companies that went public in order to obtain financing required for investment in future growth, or companies whose market capitalization slid due to various reasons. In the second case, there might be a chance that the company can stage a turnaround and its stock could rebound, but more analysis is required.

Smart money investors, such as hedge funds don’t overlook penny stocks and many of them even pile into some companies whose shares are trading at below $5. At Insider Monkey, we collect data from 13F filings of over 600 hedge funds and see how they collectively invest in thousands of stocks. Based on the third-quarter round of 13F filings, there are 19 penny stocks in which more than 20 funds tracked by us reported long positions, and in more than half of these stocks hedge funds amassed over 10% of the outstanding stock. On the next page, we are going to take a closer look at the top five penny stocks that saw the most funds holding shares as of the end of September.

But before we get to that, we should also mention that simply mimicking hedge funds and following into their penny stocks still involves a lot of risks. Hedge funds, even though they conduct extensive research on each stock pick, they can still tolerate the risk associated with investing a tiny portion of their portfolios into a penny stock. Therefore, following hedge funds’ penny stock ideas should be viewed more of a place to start and conduct a more in-depth analysis. However, there is another way to benefit from hedge funds’ 13F filings. Our strategy uses a proprietary methodology that selects the best stock picks of the best-performing hedge funds in the small-cap space. Since its inception in May 2014, the strategy gained over 67% and outperformed the S&P 500 ETF (SPY) by more than 20 percentage points (see more details here).

Having said that, let’s take a look at five penny stocks that hedge funds are collectively bullish on.

In Weatherford International Plc (NYSE:WFT), there were 29 funds in our database holding shares at the end of September, down by five over the quarter. Collectively, these funds amassed $578.97 million worth of stock, or around 12.80% of the outstanding shares at the end of September. Weatherford International Plc (NYSE:WFT)’s stock has lost 30% since the beginning of the year and fell below the $5 threshold at the beginning of June. The company provides products and services for evaluation, drilling and completion of oil and natural gas wells, and also provides pipeline construction and commissioning. In November, Weatherford International Plc (NYSE:WFT) hired advisers to sell some of its business units starting in the first quarter of 2018. The company has a huge debt pile, which gives investors reasons to concerns, but the company’s restructuring plan, might allow it to scale down, but some analysts are still reluctant to boost the company’s ratings. For example, Citi downgraded the stock to ‘Neutral’ from ‘Buy’ in November and cut the price target to $4.20 from $5.60, saying that the company’s free cash flow could be limited through 2020.

New York REIT Inc (NYSE:NYRT) saw 29 investors tracked by us long the stock at the end of the last quarter, compared to 33 funds a quarter earlier. However, the aggregate value of these funds’ positions inched up to $385.53 million from $372.56 million during the third quarter and represents roughly 29.30% of the company as of the end of September. Recently, New York REIT Inc (NYSE:NYRT), which is winding down its properties and undergoing liquidation, sold its property on 1440 Broadway for $520 million, which after paying off the loan resulted in net proceeds of $192.9 million. The REIT also put three other properties under contract for $103.1 million. New York REIT Inc (NYSE:NYRT)’s stock has slid by 61% since the beginning of the year and the company declared a liquidating dividend of $2.07 per share in November and $1.0 per share in December.

There were 31 investors holding $699.37 million worth of Zynga Inc (NASDAQ:ZNGA)‘s stock, representing 21.40% of the company’s outstanding stock, at the end of September, down from 38 funds with $694.30 million worth of shares a quarter earlier. Shares of Zynga Inc (NASDAQ:ZNGA) surged by 53% since the beginning of the year. In November, the developer of social games posted its third-quarter results, which included EPS of $0.02, in line with estimates, while revenue of $224.60 million increased by 23.1% on the year and was $12.62 million higher than expected. In addition, Zynga Inc (NASDAQ:ZNGA) announced the sequal to its hit Scrabble-like game, Words With Friends 2.

In Community Health Systems (NYSE:CYH), the number of bullish investors also declined to 35 from 38 during the third quarter, while the total value of their positions slid to $136.13 million from $206.12 million and was equal to approximately 15.50% of the company at the end of September. Community Health Systems (NYSE:CYH)’s stock has lost over 28% year-to-date, as the company missed profit and revenue estimates for the third quarter and the profit estimates for the second. In addition, Community Health Systems (NYSE:CYH) posted annual revenue decline for the last six quarters. Recently, JPMorgan analysts downgraded Community Health Systems (NYSE:CYH)’s stock to ‘Underweight’ citing structural changes in the hospital industry, balance sheet leverage and no benefit from the GOP tax reform.

The most popular penny stock among the investors in our database is Pandora Media Inc (NYSE:P). At the end of September, 49 funds held $1.19 billion worth of the company’s stock, which represented 63.80% of the outstanding shares. During the third quarter, the number of investors long the stock remained unchanged, while the total value of their positions fell by 13.84%. Last year, Pandora Media Inc (NYSE:P) captured the attention of activist investor Keith Meister‘s Corvex Management, which took an 8.8% stake and urged the company to consider a sale, but no deal was made. Earlier this year, Sirius XM Holdings Inc. (NASDAQ:SIRI) has made a $480 million investment in Pandora Media. In addition, Pandora Media Inc (NYSE:P) has got in the cross hairs of another activist, Barry Rosenstein of JANA Partners. JANA holds around 16.32 million shares of Pandora Media as of the end of September and in his second-quarter letter to investors, Rosenstein said that Pandora represents a business “with a large base of users and an enormous opportunity to grow advertising revenues and to run the business mode efficiently.

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