Is the Penny Stock Rebound Too Good to Be True?

If you love penny stocks (and judging by the number of heavy hitting stocks that have slipped into the penny stock range over the last 18 months…there are a lot of you out there) then the last month has been one of either great optimism, or great pessimism.

From March 9 to April 9, the Dow Jones industrial average gained 23%, the S&P 500 was up 26% and the Nasdaq Composite was up 30%. Small-cap stocks significantly outpaced large-caps, with the Russell 2000 Index up 36% in the same period. According to S&P’s Howard Silverblatt, this has been the steepest 23-day advance since 1933.

The recent price appreciation in U.S. equities led one investment officer to say the rally is “too explosive to be sustainable.” According to Birinyi Associates, when small-cap stocks outperform large-cap stocks to this degree after bear markets, rallies fizzle.

Will history repeat itself? Or will small-cap and penny stocks continue to trend higher?

According to one article I was reading (and no doubt there are ten times as many that point to the contrary) the pessimistic viewpoints seem to rest on one major assumption–that history is a good guide for the future.

And often times it is. Except in those cases where history has little or nothing to offer up for a comparative analysis. While we have all lived to tell the tale of past bear markets – it’s been awhile since we’ve seen anything like the last year or so.

In fact, it has probably been a century since the economy has experienced a sharp decline in the velocity of money like it did last year. Not since 1907 has the U.S. economy experienced a true panic like it did in late 2008.

Larry Summers, President Obama’s chief economic advisor, said that the economy behaved like a ball falling off the edge of a table in late 2008. Almost every major piece of economic data, the article noted, resembles the front half of a “V,” starting around September.

Vehicle sales fell to a level well below the scrappage rate, while housing starts fell to just one-third of the volume necessary to keep up with fundamentals, like population growth. The combination of a rapid decline in economic activity, rising foreclosures and mortgage defaults as well as mark to market accounting led to large losses at banks and panic selling of stocks.

If you believe some financial analysts, the economy and the market are just rebounding from the historically rare events of last year.

If this is the case, and most stocks are down and trading at what appears to be bargain prices, how can we separate the penny stocks from the chafe? After all, even excellent penny stocks saw investors overreact – sending their share prices off the table. But which penny stocks are going to bounce…and which will deservedly fall flat?

During a normal bear run, the markets will correctly anticipated the value of many stocks and discount them accordingly. A 50% drop in price is certainly a markdown — but it’s not a bargain if the value of the company has been cut in half, has deteriorating business units, or was overvalued to begin with.

This past autumn investors hammered penny stocks in virtually every sector. The question is, which penny stocks went through a justifiable correction, and which ones were the result of an erroneous, emotional overreaction?

Here are a few penny stocks you may be familiar with. While their share prices fell off the table this past autumn, they’re financially robust companies that became collateral damage- weighed down by the gloomy market sentiment. And, unlike most penny stocks, their share prices are bouncing.

Accelrys Inc. (Nasdaq – ACCL) is a profitable, financially solid company with over $53 million in cash, a strong international presence, and no long-term debt. Since the beginning of March, ACCL’s share price has risen 28.57%.

In early February ACCL announced that third quarter revenue increased 5% year-over-year to $20.6 million. Net income for the period was $1.01 million, or $0.04 per share compared to a (loss) of ($1.23 million), or $(0.05) per share in the same period last year.

California Micro Devices (Nasdaq – CAMD) is an innovative company with more than $48 million in cash, no long-term debt, and good long-term growth potential. Since the beginning of March CAMD’s share price has climbed 39.56%.

In late January CAMD announced that fiscal 2009 third quarter results (ended December 31, 2008) met revised guidance of $9.7 million. While demand for the company’s products dropped sharply due to the weakening global economy, the company’s strong balance sheet will help it weather the current economic storm. CAMD expects the current inventory correction will end by mid-2009.

Art Technology Group, Inc. (Nasdaq – ARTG) is a profitable, financially robust company with over $59 million in cash, no long-term debt, and improved operations. In early March ARTG was trading for as low as $1.95, and this week it hit an intra-day high of $2.96; for a short-term spread of 51.79%.

In March ARTG announced it entered into two strategic partnerships. In early February the company announced that fourth quarter revenue climbed 16% year-over-year to $45.4 million. Net income increased significantly to $3.5 million. Full-year revenue was up 20% at $164.6 million. The company also swung to full year profitability of $3.8 million.

If the recent upswing with small caps and penny stocks is looked at through the lens of recent history, then we could all expect the markets to retrace significantly. Since the last 18 months have been anything but typical, it’s difficult to frame some of the markets current optimism.

It’s quite possible that some penny stocks are trending back to where they were this past autumn – before emotions kicked in and they fell off the table. And that still provides astute penny stock investors with room to maneuver before the real market upswing commences.

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