THE PAPER GAME
By George Chelekis
The most important characteristic about the stock market is
the paper itself. By paper, I am using a slang term,
specialized for the financial markets and referring to the
share certificates of publicly traded companies. So innocent
sounding, and mostly ignored by the amateurs, the very word,
paper, means absolutely nothing to the average investor.
Yet, it is the paper which makes the markets move. And, if
you own and run those printing presses, as many small cap
insiders often do, you will find that the value of that
paper is arbitrarily assigned and confidently controlled
through the dynamic presence or the vapid absence of
promotions.
If you do not understand how paper and share structure
impact upon your investment or speculation, you never will
succeed consistently in the small cap stock markets.
Instead, you will lose big-time or go broke in trying to
"learn about how the market works". Well, it's time you
learned the lesson of how these markets work. THIS is the
absolute gospel that separates the professional from the
ignorant.
Cheap paper fuels the small cap stock market. Cheap paper is
also what blows up any stock and explodes the shareholders
who dare attempt to profit in such speculations. If you
never comprehend anything else about these markets,
understand just this one point: The inherent value of any
company's shares lies primarily within the range of what the
insiders, as well as what the sponsoring brokers, paid for
that stock.
If you have a company insider promoting his stock to you, it
is a simple exercise to merely ask him, "And what did you
pay for your stock?" Quite often, we are invited to
speculate in a stock, where the insiders paid around
$100,000 to $200,000 for nearly all of the company's paper.
Pull out your calculator and run that stock through its
paces. If a company has 8 million shares out and is trading
for $1/share, when the insiders only paid a few hundred
thousand for 40 percent of that stock, where does that leave
you? On the short end of the stick, that's where. The
insider is holding six-cent paper (shares which are really
worth six cents per share), while you are being asked to pay
$1 or $2 for that same share!
And what about the "leading" brokerage firms that insist on
getting cheap stock or discounted paper? Many small cap US
marketmakers demand and get a 50-percent discount on the
paper. Vancouver brokerage firms demand and get ten- and
twenty-cent paper, when they finance. Don't think the
Toronto brokerage firms are any fairer! Brokerage firms are
in the business of marketing paper to their clients. The
less they pay for it, the more they profit during the
analyst's "recommendation" or by the stock promoter's runup.
They wouldn't do, and don't do, business any other way.
The illusion of "VALUE" is created by the market
professional by vending an "asset" into the company and
confidently appraising that asset at whatever he thinks it
is worth....or at whatever price he thinks he can get away
with. The asset may be an old mined-out gold mine, which
once produced 1/2 million ounces of gold at $35/ounce, but
now that gold is $350/ounce, can economically produce more
gold. In fact, the "potential" reserves could run as high as
1 million ounces of gold. And since gold can be economically
produced at $200/ounce, then this asset should be
"appraised" at $15 million or more. Especially, and most
often, you hear the "more, more, more" or a higher price
than that mine is "really" worth. And that is what causes a
runup in the stock.....
The brokerage firms chime in, not because they really
believe in the story, but because others are likely to
swallow the story. And because the retail public will buy
this "science fiction," then they can unload their
dirt-cheap paper at quite profitable levels. And they, too,
strongly contribute to the run-up in any stock which they
get behind. Oh sure, they'll attack the insider's reputation
or the stock promoter's claims... but, later, much later,
after they've dumped all their paper into the market and
accumulated a hefty SHORT position. Before that, they'll
keep their lips sealed.
The problem, you face, is that the insider is only going to
sink enough drill holes into the ground to stir up a frenzy
among his current and future shareholders. He then can sell
off his six-cent paper to a more gullible, yet otherwise
intelligent, speculator at $1, $3 or $5/share.
Unfortunately, the drill program won't be sufficient to
prove up a gold mine. Something will go askew in the
storyline at some point down the road. And that will keep
the insider from being crucified by the securities
regulators. And the brokerage firms will be long gone from
their paper, because they've been following the mining game
since it began and know that, maybe just maybe, there are
about one or two world-class mining discoveries every decade
and perhaps five to ten really good mining stories, every
year, that can play out with any degree of longevity. After
all, you know, the junior exploration game is very risky.
You've heard the story before. You know the drill, because
you've heard the same lines more often than a sixteen-year
old virgin.
It doesn't have to be a gold mine. It can be a wildcat
exploration play. Or a "star wars" widget. A new computer
chip. A Year 2000 play. The play depends mostly on how well
the insider can tell his story. His first stop is to the
newsletter crowd. From what I've observed, newsletter
writers are probably the most gullible folks on the face of
the earth, aside from their subscribers. A good deal of the
newsletter editors have no clue as to how they would
properly appraise a gold mine. Most are asking each other or
checking with their own geological consultant. And most of
them are hardly worth a bucket of spit. They are more
interested in how much stock they can get crossed, and at
what price, than how well the story plays. Heck, if it was
all so wonderful, then there would never be any private
businesses that failed, let alone publicly traded companies
(which are essentially broke to begin with) that took the
swan dive to Hell.
Why do you think the company went "public" to begin with?
Only so that the company insiders could distribute the
majority of their paper holdings to a wide audience. From
what I can gather, there are only three basic reasons why
any private company would want to go public: (a) because it
is in financial trouble and can't otherwise raise money from
more traditional sources (like family/friends or a bank);
(b) because the insiders of a private company would like to
get their "cash out" when they retire or get tired of
running their operation and want to move on to greener or
more promising pastures; (c) when some ambitious soul has a
bee-in-his-bonnet kind of idea to manufacture the Big Widget
or to rush off to some exotic land and discover the world's
next big diamond/gold/base metal (insert one or all or
another) mine. Occasionally, those in the (c) category
actually have a great idea and will persist through thin and
thinner times to make their business work. Those are truly
the exceptions to the rule.
With the odds very much against any small cap venture, the
professional's SUPREME MOTTO for successful investing in the
financial markets becomes this: GO SHORT! You want to be a
winner in about 95% of your small cap stock investments?
Then, play it like the professionals: BET against the
company's odds for success. That's what the professionals
DO! In the mining game, the odds are, at their rosiest,
about one in 100; more cynically, about 1 in 10,000. In the
business world, more than 80 percent of all businesses fail
within five years or less. Add the "excitement" of running
an investor relations department to the thrill of keeping
your operation in the black.... and I'm sure you can see why
the market professionals are eager to hear about any
strongly promoted small cap stock. Because the word,
SHORTSALE, is stamped on that company's business plan in
letters you can see from ten miles away. While the retail
investor sees that small cap stock as the next IBM or the
next Placer Dome, the professional sees the company as the
next scuzz-ball deal that is guaranteed to rape every
investor who touches it. He is no dummy. The professional
shortseller allows enough promotion to come into the deal
only to create enough trading liquidity and upticks so that
he can amass a large enough short position to slam that
"next success story" into an early grave. By pre-selling the
shares, he can then buy all the stock back for a tiny
fraction of what you paid for it.
No matter how you cut it, the financial markets are a "paper
game." Just like the game of hot potato, most insiders and
professionals are eager to bat away any paper that comes
their way. Of course, they MUST maintain the pretense of
legitimacy or otherwise they wouldn't have such lucrative
jobs. Being on the professional side of the market is far
easier than stealing candy from a baby. And the candy they
steal from the retail investor (their clients and
shareholders) is a heck of lot sweeter.
I've spoken with far too many newsletter editors, promoters,
insiders and other market professionals, over the past few
years. What separates the REAL professional from the amateur
investor is their understanding of the company's share
structure. Few amateurs ever research this area. The sharks
ALWAYS check that out, as the first item of their due
diligence. Paper, paper, who's got the paper? What did they
pay for that paper? Simple little questions that must ALWAYS
be asked if you are to be successful in playing the small
cap stock market.
Failing to understand "share structure," is the most common
and devastating error which has victimized every investor
who has ever gotten the short end of the stick. No, it is
not only the dishonest promoter who is at fault when a stock
collapses. (Though he is ALWAYS the scapegoat. How
convenient!) The guilty ones are the brokerage firms and
their brokers and the insiders who dumped their entire
positions into the strength of the trading volume which the
stock promoter has created... and then went short on the
stock all the way back down the stock chart.
If you don't understand the share structure of any company
you are about to invest in, you are about as safe as walking
a tightrope stretched across the Grand Canyon, blindfolded
and wearing leg irons! Believe me, I know from experience.
It is NO virtue to be stupid.
Share Structure
What is share structure? What does it mean to YOU, the
innocent investor who is tired of getting fleeced? Knowing
the share structure of the company, and understanding how
paper is locked up or not, can spell the difference between
S-U-C-C-E-S-S and R-O-L-A-I-D-S.
During the fourth quarter of 1996, I began a diligent study
of what was lacking in my education of the financial
markets. After all, I came into these markets as naive as
many as you. My essays have been a journey into the heart of
darkness to understand just how these financial markets
tick. What you read, in these essays, is a journal of what I
have discovered. What was missing in my essays was this:
share structure.
Imagine watching a street hustler run his three-card monte
operation or shell game on a crowd of unsuspecting gamblers.
He's got the full set-up. A shill is there to "lose" or
"win" money from him, which draws the crowd to his table. He
knows which cards are losers or winners, or under which
shell he is hiding the little ball. But, he's got his
routine down pat. And you don't. So, he wins and you lose.
It's the same way in the financial markets. The insider and
professionals know what their paper cost them and what it is
really worth, They really only have ONE problem: How can
they dump the majority of their position at a sufficiently
profitable level? Far too many take short-cuts and dump vast
amounts far too quickly. That is where small cap stock
speculation gets a bad name. His paper cost him six
cents/share. He's worked hard, probably over a few years,
accumulating this position, paying the company's bills
(through the buying and selling of his stock) and finding
the right asset for the company. In truth, the "sweat
equity" he's put into this company could even propel the
shares to a value of (oh heck) ten cents per share. He's
probably been paying his employees with paper, paying his
consultants with paper, paying his landlord and vendors with
paper. Paying everyone with paper. It's like being in the
printing business. All one needs is blank share certificates
and a numbering kit... and he's off to the races.
Now, some of those people, which the insider pays with
paper, also like to eat, pay their rent or mortgage and heck
even invest in a company that actually produces something.
They're either patiently (and grudgingly) holding this paper
or they are dumping at the first chance they get. The
solution, as always, is to hire some stock promoter -- and
pay him in paper, too -- to create some excitement and
volume and the inevitable share runup...so that everyone
with cheap or "free" paper can bail out.
The sponsoring brokerage firm, backing this deal, has less
loyalty than a Las Vegas lap dancer on a busy night. The
brokerage firm will put up the money, to move the company
SLIGHTLY along in their exploration program or their
business plan, and will create enough "jump out" clauses and
possibilities, via options and warrants, to ensure that the
paper they buy is heavily discounted. RARELY will you find
any brokerage firm married to a story or willing to pay more
than 50% of what the paper currently trades for. Their job
is to finance deals, under the most profitable arrangement
for themselves, and to explode their brokers, who bring in
clients to buy the deal, as they blow out their cheap paper.
Believe me, there is no scarcity of those wanting stock
brokerage jobs or suckers looking for a quick buck. And none
in the financial markets would DARE call this fraud! Or they
would soon end up out of the loop. Promoters, insiders and
brokers would just shake their heads in scorn anytime
someone brought up that guy's name -- for he committed the
deadliest of sins: EDUCATING THE SMALL INVESTOR!
Unfortunately, that is how the little guy gets burned, for
he is very much out of the loop. Enough times, that is also
where the big guys and institutions can get stung. It is all
too glorious to hold 100,000 shares in "the best thing since
sliced bread," even if the shares cost the promoter nothing.
However, paper is just paper -- absolutely worthless, unless
someone gives it life, whether a real life or an artificial
one. If the share structure is shaky, and the
insiders/management are desperate to build a new wing onto
their house or to splurge on a new Ferrari, then the whole
play can easily come tumbling down. That's why many of these
plays have a two-month (or less) cycle of runup, stagger and
collapse. Look at most stock charts and you'll see that
cycle: (a) Runup, (b) Stagger and (c) Collapse. (Of course,
after the parade has died down, and the small investors are
squeezed out of the play, through attrition, THEN a new deal
and a new promoter comes along and spits in everyone's face
with the "brand new success story".)
You see, I have come to realize that Distribution only gets
a BAD name because too many promotions are being run by
short-term thinkers: unscrupulous stockbrokers, airhead
stock promoters and drunken or heavily sedated insiders.
Distribution, by its very nature, defines the financial
markets. All trading in a stock really is, is distribution:
moving stock from one individual's hands into another's.
What is so bad about that... IF it is done smoothly?
Good Plays
The safest safety net is to only speculate in good plays.
The single factor which determines a good play is the
management or the individual who OWNS the deal. In the small
cap stock markets, there may be the official face of the
company, known as the management and the names with whom you
are most familiar...and then, the guy who owns the deal. He
may be a little harder to find. There may also be a more
hidden individual -- the one who owned the shell OR even the
prospector, from whom the company got the asset, etc. When
analyzing share structure, it is important to uncover all of
these people, as any one of them can potentially cause a
stock runup to collapse. (Find out and assess who the share
dumpers will be and determine how big or small their
position is, so that you can more cleverly analyze where the
resistance levels are likely to be.)
NOTHING replaces good management, as they not only own the
deal, but also negotiate the best terms for the property
vend-in. (Historically, the worst deals are owned by the
prospector who vended in his own asset and probably believes
that only he should make money on the deal -- sounds like
the best candidate, but experience tells us that it is not).
Good management will have a "back-up play" in case the first
one doesn't work out and will also quickly stake up all the
surrounding property, when there is a discovery and before
the discovery is announced.
With good management, the company will have few obstacles
toward raising sufficient exploration or
research/development money and will be a welcome breath to
the marketplace. Insiders with good reputations will attract
truckloads of institutional money, which will stabilize the
share price at higher levels. While such management will
also assert they are "non-promotional," they will discreetly
spend fortunes on promotion and be among the first to
test-market any new promotional vehicle appearing on the
scene. (Amazing how the same insiders who repeatedly insist
that they only put their "shareholder money" into the
ground, also pay out tens of thousands of dollars to appear
at four or more "gold shows" every year.) Believe me,
EVERYONE in the small cap stock market is promotional,
unless they are the ones with stocks trading at 10 to 25
cents.
THIS OBSERVATION ALONE is what separates good management
from the sewer rats: Good management will pay cash for their
stock promotions; bad management will try to run some
short-term ropey-dope, financed on the fumes of stock
options, warrants and (occasionally) free-trading shares.
The losers don't have any money to make their play work and
will always be struggling. Good management will have plenty
of cash in the till, have the provident nature to realize
they should raise bucks when the till starts drying up, and
believe their paper is VALUABLE. The sewer rats, down deep,
believe they are pulling the sheets over everyone's eyes,
believe their deal is a scam, and look down upon their paper
as worthless.
Invariably, good management will also have a "street smart"
sense as to what promo will work and what won't. Bad
management, when they finally DO pay cash for their promo,
will buy into the worst rip-offs on the face of the earth.
It is not unbelievable when I tell you how to spot good
management from bad management. Good management has GOOD
MANNERS. They behave with civility, are polite, well-spoken
and pleasant to deal with. Not surprisingly, they are also
clean and presentable and polished. One does not have to be
a rocket scientist to figure out what bad management looks
like. The head guy generally looks dirty, smells and dresses
badly, tells tasteless and rude jokes, and so forth. Bad
Management has BAD MANNERS. There will appear to be no rhyme
or reason as to why their company does badly or their stock
performs poorly for their shareholders. Stop trying to
figure out their "share price." Simply open your eyes and
look at them. Visit their offices and see what the whole
place looks like. Listen to how they sound and what their
spiel sounds like. Failing all else, use your nose when you
meet them. If the smell of booze doesn't knock you over, or
ungodly sounds don't emanate from their body, then they may
just pass muster.
Please, though, don't confuse good manners with SLICK. The
slick can also fool you by acting "sugary" and sounding
syrupy. Their "good manners" are actually caricatures or
parodies of such manners and their behavior can leave you
with that "greasy feeling." Believe me, if it sounds oily,
smells oily and feels oily, you are dealing with a SLICK
insider. Meet a few, as I'm sure you have already done, and
you'll be able to tell the difference in a flash. They
smile, tell jokes, but they are not sincere.
Conclusion
If you are ever to become successful in any future small cap
speculation, your first mission is to get the insider to
provide you with an honest analysis of the share structure.
One must be resolute in pursuit of such a secret. Most
insiders will not part with anything more than a glib
response, like: "Oh, our float is only 600,000 shares."
Yeah, right! (Ha!) Any paper that isn't locked up in
somebody else's safe is free-trading. Don't let yourself get
misled into believing anything less. The usual responses run
something like this, "We really don't know" OR "We are so
widely distributed that we don't know" OR "Our stock has
changed so many times that we really ARE distributed." Bull
with a Capital B. Any insider can pretty much figure out who
is holding their stock, if he really wants to. Even those,
who have tens of millions of shares outstanding can roughly
determine where the majority of those shares lie. There are
such things as "Transfer Houses" and those transfer houses
keep records, available to the insiders who really want to
know how broad their distribution is or is not. Yes, it does
take some hard work to dig up this data. No, it does not
fall out of the sky and into your lap.
While you are playing detective, forget about this famous
line, "Our Public Float has XX number of shares." That is
just a "Promo Line" fed to the gullible. There are enough
loopholes that professionals can use to get around "legend
stock" or restricted stock to boggle the minds of most
amateurs. Securities regulators have a hard enough time
tracking down such distribution (and imagine the width and
breadth of their contacts and surveillance equipment!). Any
stock that isn't nailed down during a huge runup will find
its way into the market. Count on it. Expect it. Even 144
stock, which is supposedly "impossible to sell" before a
2-year hold, can be sold. All one needs to do is find a way
to "qualify" that stock and it can be sold. Some will even
short against a position and find ways to indefinitely
rollout that short position until they can get their hands
on the paper. Just as marketmakers can use "rolling
shortsales" to string out the time of delivery for 45 days
or longer, insiders and promoters can short their own paper,
nearly indefinitely, by switching brokers and even going
offshore, in order to blow out their paper. Like a kite,
their paper blows out into the four winds.
To be safe, you should stick to the RULES. Your first
premise, when approaching any small cap stock play, should
be: "This company is a shell company which finances itself
only by selling paper into the trading volume." Every play
should be approached as a pure paper play until proven
otherwise. And rarely will you be proven wrong. Share price
appreciations are meticulously designed, carefully
manufactured and aggressively promoted. To think otherwise,
is to be caught wearing a strait jacket in a lunatic asylum!
(Not a very profitable fashion statement, eh?) Be proven
wrong rather than risk losing a fortune in such
speculations. Never allow any insider or promoter to pause,
hesitate, or become reluctant in laying out the current
share structure of his company. If the insider, promoter or
your broker do not know the share structure of the play they
are recommending to you, shame on them. If you buy into the
deal without knowing the share structure, shame on YOU! Do
not play their game if they insist you play it blindfolded.
Not knowing the share structure IS going it blind. (And the
inevitable future share dilution just adds salt to your
gaping wounds!)
What I prefer is that an insider lay out the whole share
structure for me, letting me know where all of the six-cent
paper, the ten-cent paper, the twenty-cent paper, etc. is
being held. Who holds it? What are their intentions? How
badly do they need the money? And so forth. If they won't
tell me? Well, there are thousands of other companies out
there. I have no great urge to jump off any steep cliff
anytime soon. I've been burned enough times not to "just
trust them" again.
Promotion is what brings the UPTICKS. (And badly run
promotion is what causes the offers to briefly evaporate and
then return with a vengeance.) Professionals know that any
insider or promoter has only X-amount of bullets in their
arsenal and eventually every promo runs out of steam. Having
studied these manipulative tricks, in depth and from both
ends of the market, I can assure you of this: What DRIVES
the professionals OUT of a stock play is both (a) LACK OF
VOLATILITY and (b) THE ABSENCE OF ENORMOUS TRADING VOLUME.
Eliminate those two elements and you have closed the door on
virtually every trader and marketmaker. (From an investor
viewpoint, IGNORE any promoter who promises HUGE trading
volume and you will generally succeed.) During the
distribution, by steadily bringing in new buying to replace
the old buyers (who now become sellers) a stock can make a
gradual, low-profile climb up the stock chart. While some
speculators want lots of fanfare, they only desire this so
they can quickly hop in and out of the stock, playing the
volatility to their advantage. I'm sure there are plenty of
opportunities elsewhere, but you will no longer associate me
with such plays. (High trading volume, over a 3-5 day
period, generally KILLS a play with a stock zooming up and
then crashing. I'm staying away from them and you should,
too.)
Lacking an actual PROGRAM or the skill with which to
properly conduct an orchestrated PR campaign, most insiders
and promoters go for the "BIG EFFECT." The result does more
harm than good. Such contemptuous activities are the sign of
a desperate promoter, someone whose idea of fun is probably
chug-a-lugging a keg of beer or touring the town's strip
joints. These are the acts of the desperate, the mad and the
naive. Avoid such PR activity as the fatalities are
abundant. And they DO whine, later on, when the promo
machine has ground to a halt.
The best way to proceed is to sign on with someone who does
have a strategy, has gotten the insiders to agree to a
long-term growth program and tells the story honestly to a
widening circle of influence. Such stocks do NOT run up and
die within the week. Instead, such plays gradually increase
a few pennies each day, with only the rare outburst of
greatly increased trading volume. Shortsellers avoid such
plays, as there is little opportunity for them to quickly
build a large short position. Time works against the
professionals, in favor of the small investor. Professionals
have a big dinosaur in their front yard to feed, and it has
a big appetite. They want a profit fast and they want it
NOW. If you avoid such temptations, and search out the
carefully orchestrated plays, you can avoid becoming another
statistic in the small cap graveyard.
The SOLE obstacle you will have to overcome, when taking
this approach, is in disciplining yourself. You must
continue to overcome every temptation of the "quick buck."
That alone -- the vicious greed for the quick buck -- is
what will prevent you from acting sanely and rationally.
Unless you can also overcome that urge, you will never
persist in analyzing the share structure of the play to
which you've been invited to invest in. Avoid the quickie,
stickie paper plays and concentrate on the real companies
which intend to persist through the rigors of an orderly and
prolonged distribution cycle. That is what growth is all
about. (Your body didn't just grow from 2 feet to 5 feet in
three weeks, did it?) Growth takes time, not necessarily
measured in minutes or hours. Heck, it may even take more
than a few months for a good company to mature and for the
distribution phase to fully wring out all of the very cheap
paper. Knowing this should save you from foolhardiness in
the future. I only wish I had known this earlier, as I am
sure you feel the same way. However, you know it now. So USE
it in all future speculations.
What you don't know will cause you to lose money. What you
DO know will protect you. If you never ask, you will mainly
lose. If you always ask and always demand and always GET
straight answers, you will have minimized your risk far
greater than any insurance policy you can ever buy. If this
essay doesn't completely turn you off to speculating in the
stock markets, you will then learn to invest with wide-open
eyes and with a mind like a steel trap. Or you will become a
shortseller.
And, by insisting that these players start running legit
plays, you help simplify the madness into which these small
cap markets have degenerated. It has to start somewhere.
Why not with you? As the Japanese poet, Basho, once said,
"The journey of 1000 miles begins with the first step."
Copyright 1997 by George Chelekis. All rights reserved. |
