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

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It's easy to see the allure of penny stocks. The idea of getting in on the ground floor of a company, buying the stock on the cheap, and riding it to untold riches can be tempting. Unfortunately, history has shown that these companies go bust far more often than they go boom. Investors are much better off buying stock in established companies -- even those that might have a higher than average risk profile.

With that in mind, we asked three Motley Fool investors to choose top companies that they believed offered the chance for bigger rewards, with just slightly more risk. They offered up compelling arguments for Control4 Corporation (NASDAQ: CTRL), Hess Corporation (NYSE: HES), and AMC Entertainment Holdings, Inc. (NYSE: AMC).

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High-risk, high-reward

Daniel Miller (Control4): If you're looking to buy penny stocks, you're looking for high-risk and high-reward stocks. Unfortunately, for every penny stock success story, there are many, many flops -- or worse. Rather than investing your hard-earned cash in penny stocks, look for a young company such as Control4 that has immense upside and is in the early innings of a growth story.

Control4 isn't a household name just yet, but its business is providing personalized automation and control solutions to control virtually any device in a home or business. It makes your connected devices and smart home work together, and its systems are aimed at a premium consumer. Control4's target home generates $150,000 or more annual income -- it's estimated the addressable market for such a household in the U.S. is 17.2 million homes -- and the company has only penetrated about 2% of that market.

If you're wondering why Control4 is focused on such a premium consumer, it's because it offers an elite product. Consider it's more than just a pay per device, like Amazon's Alexa, and more than a managed single service, such as home security. Control4 products and systems are professionally installed, with the number of devices typically ranging between 25 and 125 for a cost between $1,000 and $50,000.

For investors, Control4 offers an opportunity in a smart-home market that should boom over the coming decades, and with a solid balance sheet, it's in position to pursue strategic acquisitions while it simultaneously drives better margins and revenue growth -- a great scenario for investors. Control4 isn't a penny stock, but it is a young company that could reward long-term shareholders if it continues to expand market share in its premium market.

Trade those pennies for black gold

John Bromels (Hess): Investors who are interested in penny stocks are probably looking for value, thinking a share price below $1.00 means the stock is cheap. And given the abysmal record of penny stocks, they're probably also willing to take on more risk than the average investor. Finally, they probably don't mind buying stocks whose shares have seen big drops recently. And that's why I think oil and gas driller Hess might be a perfect stock to consider instead.

With oil prices currently above the $60/barrel mark, there are lots of opportunities for outperformance among oil companies, many of which have seen their shares battered during the oil price slump. Hess' stock, in fact, has lost more than 25% of its value over the last three years. That sounds risky...even more so when you look at the company's most recent Q4 2017, in which it posted its 13th consecutive quarterly loss.

That loss came as production dipped and expenses rose. But things aren't all doom and gloom for the third-largest Bakken Shale driller. While it did go into debt during the oil price slump of 2014 -- along with practically all of its peers -- the company has kept its debt load manageable, with a debt-to-capital ratio of 38.7%, among the lowest in its peer group. Hess also has $4.8 billion in cash on hand to fund its growth plans, which include embarking on a promising offshore joint venture with ExxonMobil in Guyana and adding rigs to the Bakken Shale. The company also doubled its stock buyback program to $1 billion to take advantage of its own low share price.

Hess may be riskier than some of the larger oil and gas companies, but for investors looking for a cheap price and a clear plan for moving forward, it's a better buy than any penny stock.

A scary movie

Danny Vena (AMC Entertainment Holdings): It was only a little more than a year ago that AMC was riding high. At the end of 2016, the stock had soared over 40% and was near all-time highs. Now, the stock has lost 60% of its value and has struggled to regain its footing since bottoming late last year.

So, what happened to take down the theater giant? It wasn't just one catalyst for its recent troubles, but a perfect storm that hit the company.

Theaters were plagued by a weak slate of movies in 2017, with domestic ticket sales down 5.8% year over year. Then there's the ongoing squabble between Hollywood studios and exhibitors about a shortening of the traditional windowing period, and the proliferation of streaming services have all conspired to convince investors that theaters are doomed. Add to that two major acquisitions in the U.K., and the picture becomes clear.

Still, if you don't think the death of the theater is imminent, there are a lot of reasons to like AMC. The performance of Disney's Black Panther is the surest sign that people will still go to the movies, as it generated more than $1 billion on worldwide ticket sales in its first month of release.

AMC isn't sitting around waiting to see if patrons will show up. The company has embarked on a campaign to add reclining seats to its theaters, a move it says is producing a 25% return on its investment. It's also adding an upgraded food menu at many theaters, including charcuterie plates and stone-fire flatbread pizzas, as well as cocktails.

An investment in AMC isn't without risk. Last year, the company's debt grew to $4.89 billion, resulting in a debt-to-equity ratio four to five times that of its domestic rivals. The dividend currently yields 4.9%, and the company said in a recent conference call that it is committed to maintaining it. However, a high yield combined with any significant slump in theater attendance before the company deleverages, and it could find itself fading to black.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Daniel Miller has no position in any of the stocks mentioned. Danny Vena owns shares of Amazon, AMC Entertainment Holdings, and Walt Disney and has the following options: long January 2019 $85 calls on Walt Disney. John Bromels owns shares of Amazon and Walt Disney. The Motley Fool owns shares of and recommends Amazon and Walt Disney. The Motley Fool owns shares of Control4. The Motley Fool has a disclosure policy.