Investing in small companies, penny stocks, micro-cap or even small-cap companies went out of fashion as soon as the financial markets started to take a beating amid interest rate hikes. When things go south, investors exit risky equities and favor defensive, large-cap companies. But historical returns of small companies paint a solid picture and might encourage investors to consider them for long-term now that the probability of recession is decreasing.
According to a 2021 report from Meketa Investment Group, a few academics noticed an important historical trend about small-cap stocks. It was clear that small-cap stocks had “significantly outperformed larger stocks historically.” The report noted that specifically speaking, small-cap companies had outperformed large-cap companies on an annualized basis if the measurement period was expanded to at least 25 years. The report also said that since small-cap stocks are often cheap and have unrealized gains and potential, their returns are often higher than large-cap stocks. However, the report highlighted that since the great financial crisis, small-cap stocks have failed to outperform large-cap companies.
In a 2019 report on small-cap investing, analysts at S&P Global Market Intelligence highlighted that institutional investors tend to focus more on large-cap companies with strong history and liquidity. Small-cap companies often don’t get a lot of attention. However, the report said that investors who are willing to take risks can often reap huge rewards by investing in small-cap stocks. The S&P Global report said that research has shown that small-cap stocks provide more diversification and chances of returns when compared to large-cap stocks. Small-cap stocks outperformed large-cap stocks in both absolute and risk-adjusted basis, according to data from S&P Global. The time period for this data is from 2008 to 2018. The S&P Global report however noted that investors who focus on quality often find a lot of variance of quality in the small-cap universe. Investing in quality companies has proven to post higher returns. The report cited research from Asness, Frazzini, Israel, Moskowitz and Pedersen (2015) which showed that high quality small-cap stocks outperform low quality peers.
How does one find quality small-cap stocks?
“Quality can be measured in a variety of ways, including profitability levels and earnings growth consistency. Small companies with higher profit margins, better operating efficiency, solid balance sheets, disciplined financial and strong management (measured through returns on capital) should outperform,” the report said.
Best Rated Penny Stocks to Buy According to Analysts
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Going Granular
In its mid-year outlook report, BlackRock said that stubborn inflation and subsequent events have caused it to change its economic outlook. However, BlackRock believes increased market volatility has given rise to new opportunities which can be found by going “granular.” This is where stock research and paying attention to market dynamics comes in. In addition to investing in broader, safe market ETFs and large-cap companies, finding smaller companies with strong fundamentals and long-term growth potential is important for investors with limited budget, higher risk appetite and desire to make wealth from equities.
“We think that creates other opportunities to generate returns by getting more granular with exposures and views. Our approach to finding such opportunities is to overlay such granularity on our macro-based asset class views. We think dispersion within and across asset classes – or the extent to which prices deviate from an index – will be higher in the new regime amid the various crosscurrents at play, allowing for granularity….That offers more ways to build portfolio “breadth” via uncorrelated exposures, in our view.”
One of the primary reasons why small companies are worth our attention is that many of these companies are investing in innovation. Innovation creates progress and leads to growth. But over the past few years the winner-take-all dynamics of the market have given an edge to major tech companies here as well. Flush with cash, they can invest in innovation or buy smaller players to take all the gains. A report on technology innovation by KPMG investments in innovation remain moderate. However, a select few major tech companies are investing a lot of money compared to mid-market tech companies and startups. The report said that small companies are hesitant to invest in innovation since a single bad decision or investment could break their business.
However, the stock market is always teeming with companies working on the next big thing. Biotech, AI, IoT and robotics are a few areas where small companies of today could become big in the next few years if they manage to solve a key problem. That’s why, in this article, we decided to turn to Wall Street analysts and see which penny stocks they believe could gain value in the coming months. Most of the stocks in our article have over 300% upside potential according to analysts.
Our Methodology
For this article we used stock screener from TipRanks that lists penny stocks based on analyst ratings. We applied our first filter on the screener to list down only those penny stocks with “Strong Buy” ratings as of July 14. We further refined that dataset by sorting it based on upside potential that is calculated using analyst price targets of stocks. We picked 10 stocks with the highest upside potential from the current levels as of July 14. The stocks mentioned in this article have Strong Buy ratings and huge upside potential, according to Wall Street analysts.
10 Best Rated Penny Stocks to Buy According to Analysts
Protein engineering company Codexis, Inc. (NASDAQ:CDXS) is one of the notable penny stocks with a Strong Buy rating. As of the end of the first quarter of 2023, 19 hedge funds tracked by Insider Monkey had stakes in Codexis, Inc. (NASDAQ:CDXS). The biggest stakeholder of Codexis, Inc. (NASDAQ:CDXS) was Wilmot B. Harkey and Daniel Mack’s Nantahala Capital Management which owns a $21.3 million stake in the company.
Immunic, Inc. (NASDAQ:IMUX) is a biotech company working on treatments of autoimmune diseases. Immunic, Inc. (NASDAQ:IMUX) has already gained about 67% over the past six months. In May Immunic, Inc. (NASDAQ:IMUX) jumped after the company announced clinical and preclinical data to support its bowel disease candidate IMU-856 in a poster presentation at a medical event.
A total of 15 hedge funds in Insider Monkey’s database of 943 hedge funds were long Immunic, Inc. (NASDAQ:IMUX) as of the end of the first quarter of 2023.
Immunic, Inc. (NASDAQ:IMUX) shares were trading at around $2.58 as of July 13. Analysts expect the stock to reach about $13.25. This shows an upside potential of about 400% from the current levels.
In May, Baird started covering Chimerix Inc. (NASDAQ:CMRX) stock with an Outperform rating and said that the company’s phase 3 glioma candidate has a high probability of success. Baird set a $7 price target on Chimerix Inc. (NASDAQ:CMRX). Chimerix Inc. (NASDAQ:CMRX) shares were trading at around $1.21 as of July 13.
Insider Monkey’s database of 943 hedge funds shows that 13 hedge funds had stakes in Chimerix Inc. (NASDAQ:CMRX) as of the end of the first quarter. The biggest stakeholder of Chimerix Inc. (NASDAQ:CMRX) was Rubric Capital Management of David Rosen which owns a $9.2 million stake in the company.
DURECT Corporation (NASDAQ:DRRX) shares are trading at just over $5 as of July 13, while analysts expect the stock to reach $37. This shows an upside potential of $640% from the current levels.
A total of 14 hedge funds tracked by Insider Monkey had stakes in DURECT Corporation (NASDAQ:DRRX) as of the end of the first quarter. The biggest stakeholder of DURECT Corporation (NASDAQ:DRRX) during this period was Didric Cederholm’s Lion Point which owns a $6.5 million stake in the company.
Altimmune, Inc. (NASDAQ:ALT) is one of the best rated penny stocks with a Strong Buy rating and a price target that shows a huge upside potential from the current levels. Altimmune, Inc. (NASDAQ:ALT) is working on treatments for obesity and liver diseases. In May Altimmune, Inc. (NASDAQ:ALT) posted Q1 results. Adjusted EPS in the period came in at -$0.40, beating estimates by $0.08.
As of the end of the first quarter of 2023, 25 hedge funds tracked by Insider Monkey had stakes in Altimmune, Inc. (NASDAQ:ALT).
