TMFTypeoh (75.86)

The boiler room still works: The LUNACY of penny stocks

March 20, 2010 – Comments (4) | RELATED TICKERS: CMFO , CGA , AIG

Like many of you, when i was first starting out, I had zero knowledge of how the stock market worked.  If you don't know what you are doing, its very easy to look at the market as a big gambling machine, assuming that only the lucky make money.

As a uninformed investor, you naturally believe that the "easiest" way to make money is to buy small & micro cap stocks selling for $5 of less, and hope the rocket forward.

To make matters worse, there are a whole slew of "brokerage" houses out there who prey on the ignorance of the public, and cold call on unknowing individuals, selling them worthless stocks.

My father, a very educated man and a CFO, is very succeptible to such calls.  In fact, he told me about his "broker" that has force fed my dad WORTHLESS penny cap stocks such as DDD & PURE.  All of these stocks were sold to my father (who then in turn pushed them on my grandparents and other relatives), claiming that they all had "amazing" technology that was about to be a HUGE seller.

Lets look at these companies, one at a time:

DDD - Scolr Pharmaceauticals

"amazing" advantage:  Delayed release drug technology, that could be sold to pharma giants to delay the release of their drugs.

09/08/07 Rev:  958/1,972k/2,278k

09/08/07 loss: 6,500k/10,600k/10,7005k

Share price: $.84

PURE - Pure Biosciences

 "amazing" advantage:  silver based anitbacterial cleaner

09/08/07 Rev:  728k/1,400k/336k

09/08/07 loss: 7,000k/6,500k/4,655k

Share price:  $1.90

Even a casual glance at their income statement should have sent up a BIG red flag that these companies are garbage.  Both have bounced back and forth between pennies a share up to $4, based on nothing but hype, and false promises of big time revenues just down the road.

The disturbing part is that my dad bragging to me last night about how he picked up a few thousand more shares at $.50 the other day, and his broker says that they have a big annoucement coming in the next few weeks.

Sad, isn't it?

Why does this selling work so well?

1) "inside" information - brokers often claim to know hidden information about these companies, and only tell their "best clients" about this information, making the caller feel special

2) low share price - many people would rather own several thousands of shares of a garbage company, rather than own 1 or 2 shares of a great company trading at a high price (like ISRG, or AAPL)

3) short term time pressue - there is often a short term event that convinces the person to "invest now", otherwise the share price will take off, and they will miss the big share gain.

Which makes me think, if an educated man with a background in accounting can be so easily tricked  to buy large chunks of these companies, what chance does joe public have against these professional salesman?

Now, I am NOT against investing in companies with share prices under $10.  As many of you should know, a share price is meaningless.  CEO's can split shares at will, making the share prices whatever they want it to be.  Look at a company like AIG, doing a huge 20-1 reverse split to take their God awful stock from penny cap land into the mid $30's.  I must admit that when i saw AIG trading in the $30's, i did (for a split second), think that they must have got their act together.  However, after 10 seconds of research do you realize what really happend.

I think that i successfully convinced my dad to dump at least a portion of this DDD & PURE shares, and if he really wanted to own small dollar stocks to buy winners like YONG, CMFO, & CGA.  Of 3 of these are small cap, have fortress balance sheets, are profitable (in some cases HUGELY profitable), are growing fast, and have short term catalysts that will propel their share prices higher in the near future.

What's the lesson here?

1)  Share price is meaningless, intristic value is what to focus on

2)  If you get a cold call from a broker, HANG UP!  Brokers that are doing well don't make cold calls, only salesman do

3)  Do your own research, and never invest in something you don't understand.

No lets hope that i can convince the rest of my family to stay clear of garbage, and focus on the real winners....