~~A must read taken from stockdetective.com
Wherever there's money to be made -- meaning just about everywhere -- the potential for
fraud
and deceit abounds. In a United States stock market amassing trillions of dollars and
listing over
20,000 publicly-traded companies, only a fool believes that the next scam might not
await in
your next home mail delivery or incoming telephone call.
Every investor dreams of discovering and owning shares of the next Microsoft or Intel,
one-time small stocks that now rank among the world's best-known and best-run
companies.
Unscrupulous stock promoters and brokers -- and sometimes company management
as well --
prey upon this greed, offering pie-in-the-sky pitches for low-priced stocks boasting
the latest
"revolutionary" product or "21st century" technology.
All too often, these companies are all sizzle and no steak. That revolutionary product or
technology is only a concept, with no product or technology at all -- and no revenues
and no
future. There may not be even the slightest intention of making and selling a product,
only to
pump up the stock price and dump the shares at a big profit.
In the classic "pump and dump" stock scam, a company whose officers own large
numbers of
shares in its stock issues thousands or millions of shares at below-market prices, or
even for
free, to a promoter and affiliated brokers. The market is then artificially inflated
through demand
created by the brokers, using pushy, high-pressure sales tactics to lure unsuspecting
investors.
After a substantial boost in the share price, the insiders take their profits and the stock
plummets. Novices often don't realize what is happening and cannot sell in time.
The stock price may spiral back to its original levels, or even nosedive to zero.
Meanwhile, the
insiders line their pockets with the stock proceeds. The promoter perhaps will move
on to the
next deal but the company, after a reasonable interval, may recruit a new promoter to
pump
and dump the stock again. Some companies are merely stock churning vehicles,
whose top
officers have little interest in creating a real business with viable products or services.
Trading in small-cap stocks or penny stocks can prove extremely lucrative, with broker-
dealers
and individual brokers raking in massive profits far in excess of what is attainable in
the
mainstream of the securities brokerage industry. With so much potential gain at stake,
some
brokers can't resist the temptation.
Especially when there are only one or two market makers, small-cap stocks are
susceptible to
price manipulation. Broker-dealers are sometimes able to acquire a large holding of
one of
these stocks at a very low price, then the broker sales force hypes the stock through
high-pressure sales tactics.
If they can't get you over the phone, they may try to get you through the mail. Woe unto
you if
you're one of those unfortunate individuals that receive small-cap company direct
mail
promotions, because somehow you have been identified as a prime sucker in the
"pump and
dump" game.
Even press releases should not be trusted. Like corporate
profiles, press releases are designed to highlight favorable developments only. In fact,
small
companies often hire investor relations firms -- the same happy folks who create the
biased
corporate profiles -- to write their press releases! Additionally, the company that
churns out a
continuous stream of corporate profiles and press releases may be too busy promoting
itself
and not busy enough in building its business.
The corporate profile and press releases may provide interesting reading, but they are no
substitute for the company's prospectus and 10-K statement. For many small publicly-
traded
companies, little or no analyst coverage is available. The prospectus and 10-K may be
the only
unbiased, untainted information sources you can find.
Try this: Unspecified claims of "major" developments, such as a "pending" acquisition or
an
"imminent" distribution agreement with a well-known company, are common
distortions
featured in scam stock promotions. Maybe an announcement is truly forthcoming, or
maybe
somebody made one phone call. But it makes a more exciting story to tell, and that's
all that
really concerns the unscrupulous promoter or broker.
Or this: Dramatic increases in projected sales or earnings. For example, Havana
Republic
(OTC Bulletin Board: HVAR), a cigar manufacturer which began operating only in
1996, says
it expects to sell five million cigars in 1997. Toppers Brick Oven Pizza (OTC Bulletin
Board:
TBOP), a company with no reported income in 1996, forecasts $27 million in 1997
revenues
and $165 million by 1999.
These firms may actually believe their pie-in-the-sky projections, but you shouldn't.
Even
projections from the biggest and most established companies should be viewed with
caution.
Outlandish projections from small, unproven companies are hardly worth the paper
they're
printed on.
Cheap stocks aren't always cheap because they're second-rate companies. Plenty of small-
cap
companies truly possess a promising product or service that has yet to hit the market.
In the
absence of sales or profit-generating assets, you must attempt to quantitatively judge
the value
of future products -- an extremely difficult task unless it's a business you thoroughly
understand.
It is equally critical to judge the quality of the people running the business, and there
are some
effective warnings to consider:
In your prospectus, carefully review the backgrounds of company management. Does at
least
one member of top management among the president, chief executive officer or chief
operating
officer have substantial previous experience in the company's primary line of
business? Does
any part of their backgrounds indicate experience with entrepreneurial or turnaround
situations?
Did any of these situations ultimately result in the establishment of successful,
ongoing
businesses?
If the company officers' dominant overall experience involves "investment banking,"
beware.
This situation may be no more than a bunch of ex-brokers that have obtained a shell
company
to play with. This group will know how to move the stock, but probably little about
the industry
it's joining. Their intentions may be pure, or they may be out to lure gullible investors
into a
"pump and dump" scheme.
And review each of the officers listed in the prospectus. If the list of top officers
and/or major
shareholders is stacked with the CEO's in-laws, you're probably better off finding an
opportunity elsewhere.
Don't get burned by management lacking proper quality and preparation -- or motives.
Let
them play with their own matches.
A mortgage processing company that becomes a casino company... overnight? A resort
management firm that branches off into... cosmetics? Not exactly matches made in
heaven. But
they are actual examples of publicly-traded small-cap companies -- Advanced
Financial
(American Exchange: AVF) and ILX Inc. (Nasdaq Small Cap: ILX), respectively --
and ones
that also happen to have a history of excessively promoting their stock to the
investment public.
When confronted with such a company, the prospective investor should ask: Why
would a
development-stage company, which has yet to successfully develop its primary line of
business,
attempt to establish a completely different, unrelated business?
We don't know the specific motivating factors behind the moves of the above small-
cap
companies and others like them. Perhaps it's just pure stupidity. But sometimes these
are signs
of a company not really interested in building a long-term business. Sometimes these
are signs
that the company's top management, who are also the controlling shareholders, are
trying to
temporarily pump up their shares at the expense of gullible small investors -- and then
sell out.
Whatever the reason, you don't want to be a part of it.
Little things mean a lot: It's true in all walks of life, and evaluating small-cap stock
opportunities
is no different. If the fundamental analysis, pie-in-the-sky promises or management
resumes are
inconclusive, other seemingly inconsequential minutae buried in the prospectus can
flash as clear
a warning as any.
Observe the list of market makers. Research the kinds of issues each firm
underwrites, if
possible. Has the market maker engaged in a history of small-cap activity? If so, how
have
those stocks performed? If the company has only one or two market makers, the stock
stands
highly vulnerable to price manipulation. There more market makers exist for a given
stock, the
more likely they are to bid against each other and the price will more likely move to a
true
"market" price.
Study the stock's trading history. Are there any unexplained trading suspensions? Has a
typically thinly-traded stock experienced sudden and unexplained surges in trading
volume? Is
there are a sudden dilution, or history of dilution, in the number of shares
outstanding? When
promoters obtain huge numbers of shares at deeply discounted prices, or for free, the
holdings
of the other shareholders is immediately watered down. |
