It's true that a swing-for-the-fences approach is a very risky way to invest. When you find such golden opportunities, you should always make a modest investment. Any stocks with potentially robust upside usually often possess a lot of downside risk as well.
Yet there are ways to mitigate risk when pursuing stocks with high upside. If they already sport low valuations, or if they have very strong balance sheets, they likely have limited downside. In effect, such stocks already reflect ample negative sentiment, and with a few helpful catalysts, can quickly move back into favor.
Of course a little bit of luck helps. Novavax continued to deliver impressive clinical trial results. And Big Blue's acquisition of Merge came as an unexpected treat for investors.
With that in mind, here are three stocks that have triple-digit 12-month return potential.
1. Derma Sciences (Nasdaq: DSCI)
This company is pursuing a two-pronged approach to growth, which in this case is perceived as a negative by many investors. Derma has steadily built a profitable healthcare franchise in wound care dressings. That business should generate around $90 million in sales this year, and is likely worth two to three times revenue, or about $8 to $12 a share. (Shares currently trade for around $6).
Derma has also been investing in a potentially breakthrough product, called DSC-127, which could become the new standard of care for any diabetics that suffer from foot ulcers. As this article explains, this medical category is considered to be a large, unmet need, and Derma Science's Phase III drug is promising.
Of course it takes a lot of money to develop a new medical treatment. Derma has already spent $45 million to date on DSC-127, and plans to spend another $20 to $22 million by the first quarter of 2017, by which time DSC-127 will either be accepted or rejected by the Food and Drug Administration (FDA). The good news: Derma currently has $58 million in the bank, which should help the company avoid the need to raise more capital.
If successful, DSC-127 is likely worth $10 or even $20 a share all by itself. Over the next 6-9 months, investors will get several updates regarding clinical trials, all of which may help shares finally build momentum. If DSC-127 ultimately proves to be unsuccessful, then the existing wound care business alone would support a valuation at or above current levels.
2. New Media Investment Group (NYSE: NEWM)
Media stocks have been badly out of favor this year, and newspaper publishers in particular are perennial punching bags for investors. This publisher of more than 125 local daily papers, 250 weekly newspapers, 103 shopping circulars, and hundreds of related websites, is among the casualty list. Shares have slid from around $24 in the spring to a recent $15.
New Media mostly focuses on towns and cities that have populations below 35,000. Communities of that size typically have a great appeal for local advertisers, as ads can be targeted to a specific audience. Management is pairing the publishing business with a digital marketing division, which helps local advertisers build directed and effective ad campaigns, utilizing NEWM's platforms as well as other media platforms.
Yet no matter how you slice it, this company is undervalued. I like to focus on the dividend yield. Cash flow is so robust that NEWM can afford to pay a $1.32 annualized dividend, which equates to an 8% yield. This is a steady-as-she goes kind of business, and in coming quarters, investors should increasingly see that the dividend will likely stay at that level or even grow. With a greater perception of stability -- in an otherwise tumultuous media landscape -- shares are likely to rise until the dividend yield falls to the 4% to 5% range.
Analysts at Citigroup think shares are worth around $35, representing 150% upside. They reach that target by applying a 12X multiple to projected 2015 free cash flow of $2 a share.
3. Opower (NYSE: OPWR)
As any electric utility CEO will tell you, delivering power is easy for most of the year. But on days when demand spikes to peak levels and utilities must seek out expensive ancillary power on the open market the headaches begin. Independent power providers always manage to charge a very high wholesale power price right at these peaks, which ends up inflating the electric bill for consumers.
In response, many utilities are turning to Opower, which makes "demand response" software. This software enables utilities to reduce the power flow to customers that are willing to reduce their power needs. By using demand response, utilities also avoid the need to build more power plants, some of which would only be needed at peak times.
Shares of Opower traded in the mid-$20's after the company went public in the spring of 2014. But a lack of profits has soured investors, who have pushed shares below $10 these days. Thankfully, Opower has enough cash ($120 million) to see it through to projected profitability in 2017. This is a very appealing business model that will eventually deeply resonate with investors, and shares should eventually return to those heady post-IPO days.
Risks To Consider: Out-of-favor companies can stay that way for quite some time, so these stocks may not rebound their until 2016.
Action To Take: All three of these companies were out of favor long before the recent market sell-off. In recent weeks, they've slumped further still. Yet they all possess strong franchises, and over the course of time, they should start to regain traction with investors.
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