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Stocks (part F)
by
Charles Lamson
Special Situations
Penny stocks and IPOs are two special situations that deserve attention in this analysis because they are topics of great interest.
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Penny Stocks
Penny stocks, as the name implies, are a group of unlisted securities traded in the over-the-counter market. There are thousands of these companies, many very respectable.
Subsets of these stocks normally trade for less than a dollar and are often issued by highly speculative companies. When you can find pricing, it is often arbitrary and misleading.
Many of these stocks are legitimate; if highly speculative, companies. Unfortunately, they are also the weapon of choice for a particularly unscrupulous breed of stock manipulators.
Here is how this scam works:
You get a call or e-mail from a person who identifies himself as a broker with a hot deal. He may reference someone you know or use some other trick to gain your confidence. He encourages you to invest in this great, new, "undiscovered" company or some other come-on.
The great thing about this deal is that you can lock up 10,000 shares for just $5,000, again because the big boys" have not discovered this gem. If you cannot afford $5,000, he will try to get you in at a smaller amount.
You send him some money and, for the most part, that is the last you will see of it. You may get an update a few weeks after your check clears telling you things are going right on schedule, and wouldn't you like some more stock before it really starts to soar?
Behind the scenes, this broker and maybe 50 others are all calling prospects that are known or suspected of being gullible. The company they are touting may in fact be a legitimate company with no knowledge of this activity, or it can be a sham designed just for the purpose of parting you from your money.
The brokers own a big chunk of the stock and use the money you send to generate a lot of activity in the stock, which causes the price to rise. When the price gets where they want it, they dump their stock and walk away from the deal.
The stock crashes when the brokers' shares are dumped on the market and all the investors who thought they were getting in on a hot deal get burned instead.
These schemes have many variations, but result in the same conclusion: You lose your money.
Part of the problem is the market in penny stocks is virtually unregulated. If a broker from a licensed and registered dealer misleads you or does something fraudulent, you have regulatory bodies that can step in and set things right.
However, most of the penny stocks trade in an unregulated market, and many of the brokers who sell them are known securities law violators.
The bottom line is: Do not buy penny stocks.
;)
IPOs
Initial public offerings (IPOs) occur when a company first issues stock to the public. They are the subjects of intense interest because their prices can jump so radically if the market takes a liking to the company.
When a company wants to move into the publicly traded sector, it plans to issue (sell) stock to the public through an offering. This offering is highly regulated and must meet a number of requirements before the stock can be sold to the public
The company picks an investment banking firm or firms to handle the offering. Once the offering is priced and packaged, a target date is set for the public sale.
However, before the public gets a shot at the stock, it is often sold to the investment banker's real customers, the retail stock brokerage firms. They in turn will offer it to their best customers before the public has a shot.
As you can see, there are several steps along the way; at every step the stock price goes up so that by the time it hits the streets for public sale, it may already be way above the initial price listed in the IPO documents.
All of this is perfectly legal and an accepted way of doing business, although there are a couple of Internet-based organizations that are trying some different methods. One company, Wit Capital (www.witcapitalmanagement.com), allocates IPO shares on a first come, first served basis and also does the underwriting itself.
Generally, IPOs are not good investments. Most of them are trading at or near their offering price within a year of going public, no matter how intense the interest for the first offering.
The people who make money on IPOs generally are big customers of retail brokers and get the good offering price. They usually will sell all or part of their original purchase for a hefty profit and, if they think the company is going to be a significant player, hold some for future appreciation.
Most of us will not get an IPO at or near the original offering price. We have to buy when the stock actually hits the market. If the company is hot, the price can skyrocket. If you can get in early and then get out, you may make a profit.
The bottom line on IPOs is that they are not good investments for the most part. If you want to chase them, do so with the understanding that it is a highly speculative activity and is not consistent with a sound investment strategy.
*SOURCE: ALPHA TEACH YOURSELF INVESTING IN 24 HOURS, 2000, KEN LITTLE, PGS. 191-194*
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