Penny stocks fake out some investors
Sunday, May 20, 2001
By Michael Rapoport
DOW JONES NEWS SERVICE
NEW YORK - When a stock that has been beaten down in price to pocket-change levels suddenly leaps back up, it might seem like a good thing, a sign that the worst is over.
Don't bet on it.
In Wall Street's equivalent of a head fake, some big-name stocks that slid to well less than a dollar a share since March 2000 have spiked sharply recently - doubling, tripling or more within a day or two - just before the companies filed for bankruptcy or reported other negative news that slammed the stock back down.
Such price gains often seem to be harbingers of disaster, and it is unclear why they are happening.
It could be misguided optimism from small investors and day traders who foresee news coming from a company but misread its nature or its potential effect. It could be a squeeze on short-sellers - traders who bet that a stock's price will decline. It could be momentum trading, with investors jumping on what they think is a bandwagon. It could be any combination of those factors, or something else entirely.
What is not up for debate is that the phenomenon is real. Consider:
MarchFirst Inc., after a long slide that had taken its stock down to about a dime a share, spiked on April 11, surging 186 percent to 31 cents a share on volume of more than 21 million shares. The next day, the Chicago Internet-consulting company filed for Chapter 11 bankruptcy protection. It closed Friday at 0.5 cent a share.
NorthPoint Communications Group Inc. more than quadrupled over a three-day period in mid-January, going from 34 cents a share to $1.41. On the evening of Jan. 16, just after the surge crested, the high-speed Internet-access provider said it had filed for Chapter 11. Trading in the San Francisco company's stock was halted for three weeks. It closed Friday at 1.6 cents a share.
Webvan Group Inc. soared last month from 6 cents a share to close as high as 27 cents. It was still at 23 cents at the end of the day April 25. The next day, the Foster City, Calif., online grocer announced a major retrenchment - cutting nearly a quarter of its jobs and closing its Atlanta operations to conserve cash, and undertaking a 1-for-25 reverse stock split in an attempt to prevent the Nasdaq Stock Market from delisting it. The stock split has not taken effect yet; Webvan shares closed Friday at 15 cents a share.
Of course, jumps in stocks with tiny prices are pretty insignificant in dollar terms. Also, penny stocks - shares trading for less than $1 each - such as these are inherently volatile. But that does not change the fact that something unusual appears to be going on.
One possibility is that some investors may be misunderstanding what it means for shareholders when a company files for bankruptcy.
Theoretically, investors could have heard or surmised that one of these companies was filing for Chapter 11 and actually could have seen that as a plus - on the idea that the company would ultimately emerge from bankruptcy in better shape after restructuring its finances, and hence benefit shareholders.
But this idea can be wrong: A bankrupt company's common stock is often declared worthless.
A related possibility is that in some cases, individual investors are simply showing optimism that turns out to be unwarranted. Webvan announced first-quarter earnings last month along with its retrenchment. Perhaps some investors bought the stock in advance on the hope of better news, pushing the price up, and dumped it when the good news did not materialize, pushing it back down.
This could also be a short squeeze.
Short-sellers borrow stock from a brokerage in a bet that the share price will decline; it is conceivable that those shorting NorthPoint or MarchFirst could have heard about the bankruptcies in advance or deduced that they would happen soon.
Then after the shares dropped on the negative news, the short-sellers bought at the lower price to repay the brokerages - and profited on the difference in price.
The bottom line in all this: Investors should be wary of a penny stock that suddenly rises sharply in price.
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