Buyer
Beware
By Jodye Deal
Article published in The Network Journal
magazine
As the stock
market continues to fluctuate, there are many stories about investors who put a small
amount of money into a stock and watched their investment soar to hundreds of thousands of
dollars.
 Unfortunately, an increasing number of
people think the "hot stocks" to buy are penny stocks. Who can resist a
sales pitch that begins by telling prospective investors that they would be
multimillionaires by now, if they had bought Microsoft or Intel when they were struggling
companies and the prices of their stock were worth only a few bucks? The allure of
these millions is what has spurred the increasing popularity of penny stocks. The
promoter that pitches penny stocks never discloses they are referring to Microsoft or
Intel's split-adjusted price. (A stock split is an increase in the number of
outstanding shares of a company's stock in which each shareholder's equity remains the
same. The market price per share drops proportionately. Usually done to make a
stock with a high per-share price more accessible to small investors). Few great
companies were ever penny stocks.
 A penny stock is defined as a stock whose price is less than $5 a
share. Most of these companies have limited assets and most of the time their stock
activity is as little as a few thousand shares or less per day, or may go days without
trading at all. In many cases, these companies have no history of operations or earnings,
and their entire business may still be in the idea stage.
These stocks usually trade on the Over the Counter Bulletin Board
(OTCBB) and the Pink Sheets. The OTCBB is an electronic quotation system that allows
brokers to enter bid and ask prices. The bid is the highest price any buyer is
willing to pay for a given security at a given time and the ask the lowest price that any
investor has declared that he or she will sell. The Pink Sheets are updated daily by
the National Quotation Bureau and is currently available on the internet to
broker/dealers, issuers, and investors. Unlike other trading markets, like the New
York Stock Exchange or Nasdaq, the Pink Sheets or the OTCBB do not have minimum-listing
requirements. This means that companies with stock prices of just a few pennies can
get listed on the OTCBB or the Pink Sheets.
Where do you find out more about a company if you are interested
in investing in a penny stock? Good question. Any company that has more than 500
shareholders and $10 million in assets is required to file annual and quarterly reports
with the Securities Exchange Commission (SEC). Many penny stock companies do not have to
file these reports with the SEC because they do not have the requisite number of
shareholders or level of assets.
The lack of public information is one of the biggest reasons the penny
stock market is ripe with fraud. Public information is one of the most important
ingredients to making an informed investment decision. An investor cannot invest prudently
if they do not have crucial financial information about a company. Of detrimental concern,
is the fact that many of these companies have no earnings history, which usually means no
securities analyst or financial news media scrutinizes the stock. The end result is that
there is an absence of unbiased information in the marketplace. Since penny stocks usually
trade only a few thousand shares a day, if at all, they can be utterly illiquid. This can
make it close to impossible to sell if an investor has to sell quickly. Currently, there
are 3,910 securities quoted exclusively on the Pink Sheets; 1,862 quoted exclusively on
the OTCBB; and 1,917 quoted on both. That is a lot of companies out there without
information that investors need to make prudent investment decisions. Let the buyers
beware.
 Since penny stocks have low
trading prices, it is very easy for a defrauder to gain control of outstanding shares.
Once a defrauder secures a large percentage of the outstanding shares, it becomes quite
easy to artificially manipulate the stock’s price. Penny stocks are the
market’s lottery ticket. It is an agent of financial decay among those who have
not been educated about investing.
When penny stocks present such little opportunity to long-term
investors, why do they still attract attention? Many novice investors will buy them, not
having been educated that bankruptcy and penny stock companies travel together. The
combination of the opportunity to hold large share positions and the appearance of
unlimited upside potential draws new investors into this most highly speculative form of
investing. Investors may be attracted by the fact that they can buy many shares for
little money. For example, if you were investing $2000, you could buy 200 shares of a
stock trading at $10 per share. However, you could buy 20,000 shares of a penny stock
trading at 10 cents a share. Of utmost importance is the dollar amount
invested and the percentage change, not the number of shares owned.
Penny stocks are not prudent for many investors. Recent reports
have noted that penny stock fraud bilks investors out of approximately $2 billion a year.
While no system is infallible, a prudent strategy for most investors is the simple step of
writing off penny stocks completely. Assuredly, there are plenty of fantastic companies to
choose from at any given time.
Here
are some principles to follow when making any investment decision:
Always do your homework. Never invest based solely on a
“tip” someone gives you. Never base an investment decision solely on what you
read on an internet bulletin board or hear in a chat room.
Watch out for certain catchphrases like “risk-free” and
“guaranteed return”. Also watch out for promoters who tell you this is a
"once-in-a-lifetime opportunity”, and “this is an opportunity to get in on
the ground floor”.
Never succumb to high-pressure sales tactics. It’s your
money. Take time to fully research each investment decision.
Don’t invest in something you don’t understand.
If something sounds too good to be true, it probably is. So
watch out for promises that sound like the next Microsoft.
These are just a few sound principles to follow when making your
investment decisions. However, you should always make sure that you consult with your
investment professional prior to making any purchase on your own.
This
article was published in The Network Journal. Jodye Deal, contributed this article for the
New York-based magazine. If you have
questions on investing, please send them to Investing@GazelleAssociates.com.
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