These 3 Below $5 Stocks Are Cheap And Have Significant Upside Potential

Includes: AMD, STS, ZNGA
by: Trade In Mexico

Focusing on stocks that are trading below $5 can increase risks, but also offer tremendous rewards. Cheap stocks that are either out of favor, or not as well-known can provide investors with great buying opportunities, if you buy at the right time.

Low priced stocks tend to make larger moves both up and down while widely followed stocks in huge companies like Exxon (NYSE:XOM) are just not going to give me the kind of returns I want. Focusing on low priced stocks can pay off big and are often not as risky as some think, especially if you invest in companies with relatively strong balance sheets or companies with strong turnaround potential. It's a lot easier and more common for a below $5 stock to double in a short time frame, while it might take a lifetime for large caps to double.

In the past year or so, I suggested that out-of-favor Chelsea Therapeutics (NASDAQ:CHTP) shares were a buy at about $1 with "huge reward potential." It has more than tripled and recently hit $3.19 per share. Supervalu (NYSE:SVU) was heavily shorted and so cheap at just $2.32 per share when I wrote that it should be bought last year. It has just about tripled and now trades over $7 per share. There are other examples of cheap stocks that have provided great returns and although not all of my picks double or triple, it keeps me hunting for these type of opportunities. Here are three more stocks which appear to have the potential for significant gains:

Supreme Industries, Inc. (NYSEMKT:STS) shares have been consolidating around the $5 level recently, but the stock now appears poised to make another breakout move to the upside. The shares have been in a solid uptrend this year but the advance paused a few weeks ago when the market got spooked by tapering talk and also when the company released news about a settlement that some investors appear to have misunderstood. These short-term concerns have created an ideal buying opportunity for what was already a very undervalued stock. I believe that this stock will double in value over time and that it could be a takeover target by another company in this industry or by a private equity firm.

As most investors know, auto and truck sales to consumers and businesses have been strong. This company is an ideal way to play the strength in vehicle sales to commercial entities and on a general economic rebound. Supreme manufactures truck bodies, buses, armored and specialty vehicles. It makes cargo vans, "Kold King" insulated vans for refrigerated goods, specialty vehicles that are used in landscaping, construction and other service industries. It makes "StarTrans" shuttle buses, which are used by hotels, nursing homes, airports and trolleys that are frequently used by resorts and theme parks. These segments of the economy are seeing growth in most cases and that puts Supreme in a position to see financial results improve in the coming years.

The company recently announced a settlement, which seemed to be viewed as a negative by some (possibly confused) investors, but after taking a closer look, this news looks quite positive or at least neutral. On June 20, 2013, Supreme announced it settled a complaint with King County, Washington, over an order of buses in exchange for $4,737,500. While I was also initially concerned about whether this would impact financial results, upon further investigation it looks like there could be little or possibly no impact on earnings. Supreme might even make money on this settlement, here's why:

First of all, a portion of the settlement will be paid by subcontractors and this reduces the total payout, but most importantly, in exchange for the payment, Supreme will receive the buses back. In essence, Supreme is buying back the buses at a fraction (nearly half) of the original selling price and it will re-sell the buses as soon as possible. These buses are relatively new and it appears that the value when re-sold could be close to the settlement sum or even more. It is therefore conceivable that the company could even make a profit on re-selling these buses. While I am not counting on that, one thing seems clear and that is that this settlement removes the risk of ongoing litigation. It also seems like it will have little or maybe even a positive impact on earnings for the company. This is why it makes sense to buy this cheap stock now while some investors are seemingly confused and overly concerned by this issue. Another positive is that this settlement could make the company more attractive as a buyout target.

Now that we have addressed that issue, what we have left to review is an incredibly cheap valuation. While the average stock in the S&P 500 Index (NYSEARCA:SPY) currently trades for about 16 times earnings, Supreme is trading for a fraction of that. Analysts expect the company to earn 78 cents per share in 2013 and 82 cents for 2014. That means this stock is trading for just around 6.2 times earnings. Book value is $4.33 per share which also indicates these shares are undervalued since the average stock trades for more than double book value. This company has annual revenues of about $280 million and it has a solid balance sheet with only $14.8 million in debt. This financial strength reduces risks for investors and the cheap valuation makes the stock extremely appealing. With profits coming in and a solid balance sheet, the biggest downside risk appears to be another recession, but with the economy showing growth, that risk seems limited now.

With the stock consolidating for a few weeks around the $5 level, it now appears poised to make a breakout move that takes out the 52-week high of $5.26. Stocks making new highs tend to gain momentum and attract new investors and day traders. For these reasons, and a because it has a dirt-cheap valuation, I believe it is just a matter of time before this stock is trading well over $6 per share in the short-term and then up to around $8 to $10 in the next year or so.

Key Data Points For Supreme Industries From Yahoo Finance:
Current Share Price: $4.99
52-Week Range: $2.95 to $5.26
Dividend: none
2013 Earnings Estimate: 82 cents per share
2014 Earnings Estimate: 86 cents per share
P/E Ratio: about 6.2 times earnings

Zynga, Inc. (NASDAQ:ZNGA) is a leader in online and mobile gaming with well-known titles like "Farmville" and "Words With Friends." When this company first went public a couple of years ago at $10 per share, there was plenty of investor excitement about this sector and a partnership with Facebook (NASDAQ:FB). However, a rough patch hit the social networking and gaming stocks last year, and Zynga has been challenged with key employee departures and financial results that missed expectations for some investors. However, with the shares selling for just a fraction of the IPO price, there appears to be a longer-term buying opportunity at hand.

There are a number of very significant positives going on at Zynga, which include a strong balance sheet, new management, and new games that could create growth for the company. While investors still need to consider downside risks such as technological obsolescence, the constant challenge of creating popular new games, and relatively low barriers to entry, Zynga could also have significant growth potential and share price upside. Here are a few points to consider:

1. Zynga recently announced a management change that appears to give the company more growth and turnaround potential. It appointed Don Mattrick to the CEO position as a replacement to Mark Pincus who is the founder of Zynga. Mr. Mattrick has a long history of success in the gaming industry and he most recently worked as the head of Microsoft's (NASDAQ:MSFT) entertainment division. He also helped boost the fortunes at Electronic Arts (NASDAQ:EA) by focusing efforts on a limited number of really popular games. A recent Bloomberg article points out that while at Microsoft, he was interested in a buyout of Zynga and it also details how he turned Electronic Arts around, it states:

Mattrick may turn to his playbook at EA to revive Zynga. In 1991, Mattrick sold his startup, Distinctive Software, to the game giant and later began overseeing EA's North American studios. Facing bloat that crimped profits and diluted focus, he chopped the number of games in half to concentrate on titles that would have wide appeal, such as "The Sims." In the ensuing years, he tripled sales -- even with the smaller batch of games.

2. Zynga has a fortress-like balance sheet with about $1.27 billion in cash and just around $100 million in debt. The enterprise value is roughly $1.5 billion which seems low when considering that it has annual revenues of around $1.2 billion. This financial strength reduces risks for investors and it gives the company the flexibility to develop new games or acquire promising start ups. The cash balance and low enterprise valuation could also make Zynga an attractive takeover target.

3. Zynga appears to be moving fast to develop areas of high potential growth. It recently announced it would have a game based on the HBO series called "Game of Thrones." A company called "Disruptor Beam" designed the game and it was launched on February 21, on Facebook. It recently had more than 500,000 users but with Zynga involved it could grow significantly in the coming months. The game allows you to participate in the world of Game of Thrones and since it is growing in popularity, this could boost results for Zynga.

The company is also expanding into real money gaming and it has a couple of websites in the United Kingdom, "Zynga Plus Poker" and "Zynga Plus Casino." Not long ago, Zynga applied for a gaming license in Nevada. This could lead to huge opportunities, if some states relax gaming laws. The move into real money gaming could be further accelerated by the recent acquisition of a company called "Spooky Cool Lab" and this is one reason why Zacks upgraded the stock to a strong buy on July 10, 2013. (Spooky Cool Lab has a number of social and real money gaming executives working for it.)

Since this company has financial strength and a well-known brand name along with millions of users, the main downside risk appears to be whether or not management executes. However, Zynga shares appear too cheap to ignore based on the upside potential that it has. The positives include a strong balance sheet, new games and real money gaming potential, and Mr. Mattrick, who has a proven track record in this industry. That is why Zynga shares look like a solid buy now, and even more so on any pullbacks.

Key Data Points For Zynga, Inc. From Yahoo Finance:
Current Share Price: $3.30
52-Week Range: $2.09 to $5.25
Dividend: none
2013 Earnings Estimate: a loss of 5 cents per share
2014 Earnings Estimate: break-even results
P/E Ratio: n/a

Advanced Micro Devices, Inc. (NYSE:AMD) shares plunged to about $2, then recently rebounded to around $4.60, only to drop again to below $4, after the company announced financial results. This stock appears to be worth buying on pullbacks like this as it remains in an uptrend. In addition, it appears that many investors and analysts are starting to recognize the upside potential in this stock as a number of new developments could lead to a profit turnaround in the future.

AMD has been losing money in recent quarters and the chip sector has been challenging due to the decline in PC sales. Declining revenues and losses are not a good combination and these issues heighten downside risks for investors. However, there appears to be a compelling turnaround story developing for this company.

The turnaround could be based on chips for the graphics and server markets. AMD recently announced a deal to provide chips for the new Sony (NYSE:SNE) PlayStation 4 game console and the next-generation Xbox from Microsoft . AMD could also be poised to make inroads into the server market due to an acquisition it made less than two years ago: AMD bought a company called "SeaMicro," which has promising new technology that could allow it to compete in the server market. This market is currently dominated by Intel (with a 96% share). This could start to add significant revenues for AMD in 2014. One analyst thinks that AMD shares could be headed back to $8 and a recent Barron' article details the bullish outlook, it states:

This time could be different. SeaMicro's technology looks good; its management team, astute; and the market opportunities, promising. One newly converted bull, Dan Niles, who bought AMD this year after being negative on its prospects last year, thinks the shares could go to over $8. Niles, who works at AlphaOne Capital Partners, sees this happening if AMD's revenue grows to $7 billion by 2015, and if its stock multiple of enterprise value to trailing 12-month sales rises from 0.7 times now to 1.3 times, which would bring it closer to Intel's 2.2. He considers this very possible.

Not everyone is bullish and some analysts have price targets of just $4 for this stock. Tech companies can be rendered obsolete in a relatively short time if another company comes out with a better product. This along with recent losses could be some of the biggest potential downside risks for AMD shares. Investors took the shares down a bit after the company reported Q2 earnings even though results were better than expected. The problem was that the company guided for gross margins to drop to 36% from last quarter's 40%. It also said gaming chips for Playstation and Xbox consoles will offer low double-digit gross profit margins. All of this leads me to believe that major challenges remain and that a turnaround (if any) will not happen overnight. That's why there is no apparent need to chase the stock, but the long-term potential of a return to profitability and a $8 price target makes these shares worth considering on dips.

Key Data Points For Advanced Micro Devices, Inc. From Yahoo Finance:
Current Share Price: $3.90
52-Week Range: $1.81 to $4.65
Dividend: none
2013 Earnings Estimate: a loss of 21 cents per share
2014 Earnings Estimate: a profit of 10 cents per share
P/E Ratio: n/a

Out of these three picks, Supreme is my top choice because it is cheap, plus it has a solid balance sheet and it is already very profitable. AMD and Zynga also appear to have great upside potential, but I view those two picks as higher-risk due to the fact a turnaround in profits is needed.

Data sourced from Yahoo Finance. No guarantees or representations are made.

Disclosure: I am long STS, ZNGA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Please consult a financial advisor before making investments.