Hedge funds aren’t the type of investors that regularly buy shares of penny stocks. However, on some occasions, they can identify opportunities in the segment of cheap stocks by looking a bit further than the crowd and noticing something that others might not see. However, most companies whose stocks trade in the penny stock space, are very small and investing in them is highly risky, which is why even if hedge funds buy a stake in one of these companies, they are hedging their risks. Also, due to the relatively small sizes of these positions, they can afford to lose some money on these bets, which may not be the case for retail investors. Nonetheless, we have identified five penny stocks with a lot of optimism among the elite hedge funds that we track. However, all of these stocks posted huge losses during the third quarter and we should warn you that we don’t know if these investors maintained their positions during that time, since the current round of 13F filings is still in progress. However, judging by the long-term focus of many of them, there is a chance that a majority of the funds that acquired shares will keep them until the stocks rebound.
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Let’s take a look at the penny stocks that made our list. We will start with two energy stocks. The whole sector has been significantly affected by the slump in crude prices, sending the prices of many energy stocks below $1. One of the oil & gas companies that hedge funds seem to like, despite an 80% slide year-to-date is Penn Virginia Corporation (NYSE:PVA). Investors were most likely bullish on the company because they were betting on it being taken over, with rumors that BP might be interested in it arising back in June (see details). The stock is in risky territory, trading below $1.00 for a long time, which could lead to its de-listing from the NYSE if the situation does not improve. Penn Virginia Corporation (NYSE:PVA)’s shares gained 39% in the last month, which pushed it above its 52-week low of $0.34, though they still have a lot of room to cover until they reach the 52-week highs of over $9.00. Analysts currently have a consensus price target of $5.90, which also indicates huge upside potential (although some of the price targets in the consensus may be old). However, with crude prices still at very low levels, the company might need a miracle and soon, if it wants to stay afloat. Meanwhile, George Soros‘ Soros Fund Management held 6.0 million shares of Penn Virginia Corporation (NYSE:PVA) at the end of June, followed by billionaire quant Israel Englander’s Millennium Management with ownership of 3.53 million shares.
Two other energy penny stocks that enjoyed some attention from hedge funds are Key Energy Services, Inc. (NYSE:KEG) and SandRidge Energy Inc. (NYSE:SD). Both stocks slumped by around 70% during the third quarter and are currently trading only slightly above their respective 52-week lows. A total of 20 funds held shares of Key Energy Services, Inc. (NYSE:KEG) at the end of June, amassing nearly 30% of the company at the time. Two funds managed by billionaire investors held shares of Key Energy Services, Inc. (NYSE:KEG), namely Ken Griffin’s Citadel Investment Group and Jim Simons’ Renaissance Technologies, both of which increased their stakes, to 12.89 million shares and 2.80 million shares respectively.
SandRidge Energy Inc. (NYSE:SD) was included in the equity portfolios of 18 funds, which held positions equal to 23% of its outstanding stock at the end of June. Among them, billionaire Prem Watsa of Fairfax is the most bullish on SandRidge Energy Inc. (NYSE:SD), amassing 50.89 million shares, which accounted for 3.25% of Fairfax Financial Holdings’ equity portfolio. Millennium Management also reported ownership of 1.69 million shares, the stake being increased by 162% on the quarter.
XOMA Corp (NASDAQ:XOMA) is the hedge funds’ top penny stock bet from the biotech industry. It lost 80% during the third quarter. Overall, it is down by 71% year-to-date, mainly on the back of terrible results from a Phase 3 study that did not meet its primary endpoint. However, earlier this month, Xoma managed to sign a licensing agreement with Novartis, which includes the global development and commercialization rights to Xoma’s growth factor-beta antibody program. The deal will provide XOMA Corp (NASDAQ:XOMA) with up to $517 million, including a $37 million upfront payment. The rest will depend on the future achievement of its development and hitting certain milestones. Xoma might also receive royalties from future product sales. On the back of the news, several analysts reiterated their bullish ratings, including Wedbush, which reaffirmed an ‘Outperform’ rating with a price target of $6.00, down from $11.00. Among investors bullish on XOMA Corp (NASDAQ:XOMA) are several healthcare-focused funds, such as Baker Bros. Advisors and Kevin Kotler’s Broadfin Capital. In addition, D. E. Shaw, founded by billionaire David E. Shaw, and Millennium Management were also long Xoma at the end of June.
Finally, LeapFrog Enterprises, Inc. (NYSE:LF) was included in the 13F filings of 17 funds from our database, although they held just 8.50% of its outstanding stock at the end of June. LeapFrog develops toys and educational entertainment for children. The 85% drop in the stock over the last year follows a series of earnings reports that missed estimates, although analysts expect LeapFrog Enterprises, Inc. (NYSE:LF) to deliver steady revenue growth for the next two years. Among the investors from our database, some of the largest stakes in LeapFrog Enterprises, Inc. (NYSE:LF) were held by funds that are managed or were founded by billionaires, such as D. E. Shaw, which reported owning 1.65 million shares, as well as Chuck Royce’s Royce & Associates and Jim Simons‘ Renaissance Technologies, with stakes of 794,100 shares and 494,787 shares, respectively.
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