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Portrait of a "Pump-And-Dump"
- by the Stock Detective
The Stock Detective recently received an e-mail from an on-line "tip-sheet" called The Future
Superstock, whose publishers are often paid fees for "analyzing" the stocks therein. A rather
popular website for small-cap stock promotions, we had known about it for some time. But the
sheer audacity of its e-mail piqued our curiosity.
The Future Superstock boasted about its stellar track record for recent stock selections,
conveniently citing high prices achieved shortly after its "recommendations" (our word, not theirs)
were released. However, a quick review of the price/volume charts for several of these companies
reveals a sharp spike in price and volume followed by a steady decline - the signature characteristic
of the dreaded "pump-and-dump."
What's a pump-and-dump, you say? If you're not sure, you're probably not cynical - or insane -
enough to dare venture into the risky world of the smallest of the small-cap stocks.
Getting Dumped On
The road to successful small-stock investing is littered with hazards. The unpredictable
development of smaller companies is but one of many potential fundamental risks for investors. But
small-stock investing involves another set of risks that have nothing to do with sales and earnings
growth or debt ratios.
Smaller stocks are particularly susceptible to market manipulation by corporate insiders and
affiliated parties, accomplished in a number of ways. Among the most notorious is the
pump-and-dump, where these insiders pump up the stock price and dump the shares at a big profit
- while individual investors take a big fall.
In its ugliest form, unsuspecting investors are compelled to purchase thinly-traded and/or
low-priced stocks through aggressive marketing and advertising. These promotions are often
disguised as legitimate, unbiased research with a stated or implicit buy recommendation. (See
Stock Detective Guide to Pseudo Stock Research and Phony Financial Reports.)
The subtlety and professionalism of these promotions may vary widely, but the purpose is
nevertheless clear and intentional: to benefit a small number of large shareholders at the expense of
a larger number of small shareholders.
Stock promoters may be hired to help a company repatriate shares owned by venture capitalists or
other early investors seeking to cash in on their investments but requiring additional liquidity to do
so. Public relations firms may be hired even after an IPO to help boost liquidity and relieve the
underwriter of its inventory, especially in small IPOs (under $10 million) where there may have
been only one or two selling firms. Legitimate businesses sometimes have legitimate reasons for
selling their stock.
But far too often, the benefitting parties in these market manipulations are not legitimate venture
capitalists but opportunistic stock scammers attempting to turn millions of shares of
cheaply-acquired paper into cold, hard cash - courtesy of unsuspecting individual investors.
The mechanisms and manifestations of these scurrilous schemes may
vary but typically include a burst of stock promotion followed by a
large selloff of free-trading shares. Sometimes the hyped company is
a legitimate operating business with reasonable goals. Often,
however, the actual business is little more than a clever story and a
few questionable assets. (For examples, see previously profiled
Stinky Stocks such as Dynacom Communications, which never had
an operating business, or Say Yes Foods, which does but spends a
suspiciously inordinate amount of effort and resources to promote its
stock.)
Future Super-shlock
Pseudo-research publishers are seldom the perpetrators of pump-and-dump schemes, but they
are, too often, the facilitators of fraud. The promoters can't maximize their chances for success
without the veneer of respectability provided by the pseudo-researchers, and the publishers don't
have a story without the promoters.
In the case of The Future Superstock, the publication touts its track record for its Stock-of-the-
Month-style selections as if it were providing honest, unbiased research when, in fact, it sells its
services for the right price.
"In June, we brought you Dawson Science Corporation (ticker: DWSC) as our June Stock Pick,"
according to the aforementioned e-mail. "Dawson Science was profiled between $3.50 and $4.00
per share. Dawson Science has been a solid performer, trading as high as $10.625 for a 175%
gain.
"Our July Stock Pick, National Healthcare (ticker: NHMCF), was profiled at $4.25 per share.
Over the past 150 days, National Healthcare has traded as high as $6.00 per share for a 41%
gain.
"Our September Stock Pick, Golden Phoenix Minerals (ticker: GPXM), was profiled at $3.75 per
share. Since profiled, Golden Phoenix has appreciated nicely and has traded as high as $5.875 for
a 57% gain."
True enough, but there's far more to these little stories of self-congratulation. As their current charts
reveal, these impressive gains were, in fact, short lived and probably provided more liquidity for
sellers than profits for buyers.
Dawson Science, for example, closed at $4.69 on November 10,
above The Future Superstock's proclaimed profile price but
down 56% from its short-lived pump-peak. National Healthcare,
at $3.50 on November 10, is down 18% from the time of its
profile and 42% from its subsequent high. Golden Phoenix, which
closed at $2.50 on November 10, is down 33% since its
September profile and 57% from its short-lived pump-peak.
The Future Superstock, of course, only touts the 175%, 41%
and 57% theoretical gains. Few, if any, of the website's readers
would have actually realized such gains.
As one might guess, the publication's stock selections not
mentioned in the e-mail have fared far worse. Its February Stock
Pick, All-American Food Group (ticker: AAFG), surged from
$4.00 to $4.75 only to sink to $1.375 on November 10, down
65% since its profile and 71% from its short-lived pump peak.
National Affiliation Corp. (ticker: NAAC), the March selection,
was profiled at $4.31, never received the expected bounce and
now languishes at $1.625 - a 62% drubbing. Promotion-happy
Say Yes Foods (ticker: MILK), which stood at about $4.75 at
the time of The Future Superstock's December 1996 analysis and
quickly rose to $5.25, has since soured to its current $2.81,
down 41% since its profile and 46% from its subsequent high.
As a matter of fairness, not all The Future Superstock
recommendations display pump-and-dump tendencies. A handful
even post sizable gains. Nasdaq-listed Labor Ready (ticker:
LBOR), described in the e-mail as "the first company that The
Future Superstock ever posted on our website," has gradually
risen ten-fold since first "following" the company at $2.375 per
share. (We're not told whether "following" the company means
the same as profiling it as a Stock-of-the-Month-style
recommendation.) Indeed, Labor Ready, from its chart anyway,
seems worthy of further investigation.
Putting Its Mouth Where The Money Is
But The Future Superstock wants to have it both ways. It
describes itself as "an independent publication committed to
providing timely and factual analysis of selected companies.
Companies are chosen on the basis of financial strength and
potential."
On the other hand, its disclaimer reveals: "The Future Superstock and/or its affiliates act as
consultants to the companies, and do receive compensation for promotional or public relations
services to such companies in stock or cash. The Future Superstock was compensated 35,000
shares for its public relations services and for the dissemination of this report."
What kind of "independent publication" receives compensation from the actual companies it
purports to analyze? Why should anyone consider such analysis as anything more than a paid
advertisement, designed to "accentuate the positive and eliminate the negative"?
Note also that The Future Superstock did not select an August Stock Pick. Was this "independent
publication" unable to find a worthy stock selection at a time that the overall market was soaring to
all-time highs and the Microcap 50T Index registered a blistering 11.8% one-month gain? Or
was no company able to come up with the sufficient compensation?
The Future Superstock and publications like it may, from time to time, profile an actual
emerging-growth investment opportunity, but not because a team of professional research analysts
unearthed an unknown jewel of a company. It's because someone paid them.
By the way, a word of caution if you are thinking of "front running" a pump-and-dump promotion -
i.e., buying and selling in tandem with the promoters in order to flip a position for a quick gain.
Don't try to beat the promoters at their own game. Unless you are part of the insider group behind
the promotion, you have no way to know when or how many shares will be sold ahead of your
orders.
Perhaps if you wait for the pump-and-dump to run its course, an actual opportunity stock may
settle down and trade on the pure fundamentals of the business. Or, if it is a scam stock, the price
could fall to zero. Are you willing to take that risk?
For the record, The Future Superstock's November Stock Pick - for which it received 35,000
shares as compensation - is a bulletin board issue called Keystone Energy Services (ticker:
KESE). Although the company has yet to register any sales or earnings, it is lauded as an "MCI or
Sprint in the making." Keystone Energy's estimated 1998 revenues, according to The Future
Superstock: $170 million.
Better swallow a healthy dose of cynicism - or insanity - before invest |
