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Watch
Out For Ground Floor Opportunities
a.k.a.
Pump & Dump
I don’t
know about you, but everyday I receive e-mails from people I don’t
know alerting me to opportunities to get in on the ground floor of
exciting new businesses. For instance, just within the last few days
I’ve been told about:
- A
company that as recently as April 2003 was struggling to establish
an insurance brokerage operation, but instead decided to go into the
electric power generation business using wind turbines.
- A
supplier of services to the entertainment industry that projects
revenues exceeding $150 million in 2005, but as far as I can
determine, has never earned a dime or even filed a financial
statement with the Securities and Exchange Commission.
- An
independent moviemaker that says it has committed funds to acquire
properties to be produced as “high concept” motion pictures
targeted at major studio distribution, but whose balance statement
revealed that the firm doesn’t have any cash to spend on anything.
All of these
stories sounded intriguing at first read. After all, who wouldn’t be
tempted? With share prices well under $1, you could strike it rich if
you get lucky and load up on a stock that eventually goes to $5 or $10
per share.
Too Good
to Be True?
Unfortunately,
the odds are stacked against you. Many of these companies are more about
making money from selling stock to unsophisticated investors than they
are about starting a groundbreaking new business.
Most
entrepreneurs planning on building a business that will eventually sell
stock to the public raise startup cash from banks, private investors, or
from venture capitalists. Then when the undertaking has advanced from
concept to an operating business, the company, with the assistance of an
investment banker, sells shares to the public via an initial public
offering, or IPO.
By contrast,
the typical company that promotes its stock via e-mail typically came
into existence when its promoters bought out a defunct “shell
corporation,” that is a corporation with publicly traded stock, but
with no significant business. For instance, the movie production company
that I told you about earlier was a mining company when it was
originally incorporated.
Smoke Out
The Pipedreams
Fortunately,
it doesn’t take much time to separate out the viable investment
candidates from those that are pipedreams, or possibly even scams. You
can do it in just a few minutes using information readily available on
Yahoo! Here’s how to go about sizing up an unknown company.
Start by
getting a price quote on Yahoo’s main finance page (finance.yahoo.com).
Check the current trading price (last trade). Most worthwhile stocks
trade at $5 and above. So conservative or risk-averse investors should
avoid all stocks trading below $5 per share.
However, many
tech stocks tumbled into the $1 range when the bubble burst, and it’s
possible that some viable candidates may still be trading at that level.
Adventurous investors can look at cheaper stocks, but be cautious about
any stock trading below $1 per share, and avoid all stocks that are
currently trading below $0.50.
Be aware that
stocks promoted via e-mail typically move up in price for the duration
of the e-mail campaign, so avoid stocks that have mostly traded below 50
cents per share. You can see a stock’s daily price history by
selecting Historical Prices on the left-menu.
Next, check
the company’s annual sales by clicking on Income Statement in the
Financials section of the left-menu. Yahoo will display the last
four-year’s income statements. The top line of each column shows the
total revenues (sales) for the year. Most public corporations crank out
sales in excess $50 million annually, which would, since Yahoo lists the
figures in thousands of dollars, be displayed as 50,000.
If you’re a
risk-averse investor, disqualify companies with less than $50 million in
sales. Otherwise, use $10 million as your minimum.
For more
recent data, select the Quarterly Data option, which shows the last four
quarter’s sales figures. A corporation that is doing real business
should have rung up at least $5 million ($10 million for risk-averse) in
sales in its most recent quarter. Disqualify any company that doesn’t
meet that requirement.
Next check
the company’s solvency by selecting Balance Sheet and then Quarterly
Data. Use the most recent quarterly data. Compare the Current Assets to
the Current Liabilities. Disqualify any companies whose current
liabilities exceed current assets.
Get a Good
Laugh
After
you’ve checked the numbers, take some time to learn something about a
company’s history by reading the management discussion portions of its
quarterly and annual SEC reports.
That’s easy
to do on Yahoo by selecting SEC Filings (left-menu) and then clicking on
the Summary link under each annual and quarterly report listing. Start
with the oldest available reports and work your way to the most recent.
I’m confident that you’ll find it more fun than reading a novel. Do
yourself a big favor by disqualifying all stocks that started life in a
radically different business.
Just doing
these quick checks will eliminate most stocks that don’t have real
businesses. But passing these tests simply means that you’re dealing
with a real company, not that you’ll make money owning its shares.
published 3/21/04 & 3/28/04
Here's
an older, but updated, column on the same topic
If
you’re like me, you get plenty of junk email daily. Interspersed with
the Viagra and “work at home” missives, I usually receive at least
one message daily touting an undiscovered stock poised to soar.
I
know that these stock-hyping emails work, because occasionally I check
the touted stock’s trading volume. Typically, the number of shares
traded daily jumps by a factor of four or so, for two or three days
after the email.
The
stock-hyping emails are enticing. For instance, I was going through my
files yesterday, and I found an email that I received a couple of years
ago from a “new financial service striving to find investment
opportunities.” In it, someone, let's call him Paul Promoter, offered
to be my new financial advisor. Paul said his analyses would save me “hours
of research,” and that each recommendation he made would be
"extensively researched.”
Opportunity Knocks
Paul was plugging a company; lets call it “Miracle Tech,” that was
developing batteries for the automotive and electric car industries. Its
mission, according to Paul, was to exploit patented and proprietary
battery technology to create “the ultimate battery, characterized by
superior power, higher capacity, lighter weight, and minimal acid and
lead content.”
The
battery project alone would have consumed the resources of most young
companies, but not Miracle Tech.
The
firm was concurrently developing a device to detect the presence of
water in storage and fuel tanks. Wait, there’s more! Evidently grain
must be dried before storing, and Miracle Tech was also working on a
microwave device to do just that. Even that wasn't enough to satisfy the
eager Miracle Tech scientists. The company was also designing equipment
to join large diameter pipes together using a magnetic technology.
Paul
said the he expected Miracle Tech’s earnings to grow from a loss of
$0.11 per share in 2001 to a profit of $0.89 in 2005. Based on those
forecasts, Ted targeted a $1.80 per share stock price by December 2002,
and $18 by the end of 2005. At the time, the stock was trading at $0.48
per share, so Paul was talking about a tidy 3,000 percent gain in four
years.
Shoestring Operation
Obviously, Miracle Tech must have been employing hordes of research
scientists and technicians to manage the simultaneous development of
those impressive products. But here’s the real miracle: Miracle Tech
was doing the whole job with a staff of only 10 fulltime, and two
part-time employees, toiling away in a 5,000 square foot facility that
it was renting for $2,000 per month.
I’m
not sure how Miracle Tech was paying even that meager staff since, as of
its most recent balance sheet, it had only $8,000 in the bank and its
debts far exceeded its assets.
With
an empty bank account, Miracle Tech must have been cranking up hefty
sales. Wrong! Miracle Tech’s latest report showed that its previous
12-months' sales amounted to a flat zero. Nothing!
I
suppose that it was theoretically possible for Miracle Tech and its
shareholders to hit the jackpot with one of their many projects.
However, most companies developing products as sophisticated as Miracle
Tech’s, spend tens of millions of dollars, and employ staffs numbering
into the thousands.
To make a
long story short, I checked on Miracle Tech's progress yesterday, more
than two year's after I'd received my new friend Paul's tip. The amazing
thing is that Miracle Tech is still around. The previous day, 2,000
shares had changed hands at $0.04 each. The company was selling stuff
too, racking up a grand total of $25,000 worth of sales in its previous
12 months. How was it doing financially? As of October 31, Miracle Tech
had $3,000 in the bank, but owed $285,000, all of it short-term debt.
Hyping Pays Well
How did Paul Promoter goof so badly? What about all that careful
research that Paul promised when he introduced himself? Reading the
disclaimer at the end of Paul’s report revealed that Miracle Tech paid
him to prepare and mail the report, in this case, 100,000 shares of
Miracle Tech stock. It’s legal for Paul to promote Miracle Tech, and
to get paid for it, as long as he reveals the payments in the document
and confesses that Miracle Tech, in truth, supplied his so-called
research.
Companies
like Miracle Tech hire people like Paul to create investor interest,
moving the stock price up, and equally important, increasing the trading
volume, thereby allowing insiders to dump their holdings. This process
is known as “pump and dump.”
Quick
Hype Checks
Here are some simple checks you can run to spotlight the Miracle
Techs of the world, so that you don’t waste time researching, or
worse, buying them. You can find everything you need on Yahoo (finance.yahoo.com).
Here's what I did two years ago, except that' I've changed the details
on where to find the info to correspond to Yahoo's new format.
Start by
getting a price quote.
Price and
Volume: Many professional investors shun stocks trading at prices
below $5.00 per share. However, scores of “fallen angel” tech stocks
are trading in the $2.00 to $5.00 range, so $1.00 would be a reasonable
acceptable share price in this market. Back then, Miracle Tech was
trading at $0.48, so it flunked.
Next, click
on Key Statistics in the Company section on the left-menu. In the
Valuation section, check the company's market capitalization and
price/book ratios.
Market
capitalization is the total value of a company (shares out multiplied by
the share price). Larger companies are considered safer investments than
smaller companies, and those with market-caps below $100 million or so
are considered too risky by many investors. You will avoid most “pump
and dump” stocks by staying above that level. Miracle Tech’s $12
million market-cap easily disqualified it in this category.
Price/book,
(share price divided by stockholders’ equity) is the appropriate value
gauge when a company has neither sales nor earnings. Price/book ratios
range from below 1.0 for value-priced companies to 20 or so for fast
growing startups. Avoid companies with ratios exceeding 25. Miracle Tech
flunked because its book value was negative, thus making its P/B not
measurable.
Next look at
revenue in the Income Statement section.
Little
or no sales is a hallmark of pump and dump stocks. Most companies worth
considering rack up annual sales (sales ttm) exceeding $50 million, so
avoid companies below that level. As mentioned earlier, Miracle Tech’s
annual sales totaled zero.
Finally,
check current ratio in the Balance Sheet section.
Current
ratio, a comparison of a company’s assets such as cash, inventories,
and accounts receivables, to its current debts, is a good measure of a
company’s financial condition. Current ratios higher than 1.0 mean a
company’s current assets exceed its current obligations, and values
below 1.0 signal problems. For instance, a current ratio of 0.5 means a
company current assets only amount to half of its current debt. Avoid
companies with current ratios below 1.0. Miracle Tech’s current ratio
was 0.3, so it flunked this test also.
If
you want to know more about a “pump and dump” suspect, check out the
company’s latest quarterly and annual reports on Free Edgar (www.freeedgar.com).
That’s where I learned about Miracle Tech’s staff of 10 and its
$2,000 per month world headquarters.
These
guidelines will help you avoid the most flagrant “pump and dump”
stocks, however there’s much more to consider before deciding to
invest. We’ll describe additional considerations in future columns.
updated 3/1/04
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