|
I don’t know about you, but I get daily email from people I don’t
know advising me to buy stocks that I’ve never heard of. These missives
read like research reports from professional stock market analysts profiling
companies that have just developed exciting new products or services
with huge market potential.
I know that these stock-hyping emails work, because occasionally
I check the touted stock’s trading volume. Typically, the number of shares
traded daily jumps by a factor of four or so, for days after the email.
Back in November 2001, I received a particularly enticing report
from a “new financial service” that said it was “striving to find investment
opportunities.” I’ll call this helpful adviser Ted Touter. Ted said
his analyses would save me “hours of research,” and that “each recommendation
is extensively researched.”
Opportunity Knocks
Ted was plugging a company, let’s call it Miracle Tech, that was
developing batteries for the automotive and electric car industries. Its mission,
according to Ted, was to exploit patented and proprietary battery
technology to create “the ultimate battery, characterized by superior power,
higher capacity, lighter weight, and minimal acid and lead content.”
You’d think that the battery project would consume the resources
of most young companies, but not Miracle Tech.
The firm was concurrently developing a device to detect the
presence of water in storage and fuel tanks. Wait, there’s more! Evidently
grain must be dried before storing, and Miracle Tech was working
on a microwave device to do just that. Even that wasn’t enough to
satisfy the eager Miracle Tech scientists. The company was also designing
equipment to join large diameter pipes together using a magnetic
technology.
Ted expected Miracle Tech’s earnings to grow from a loss of
$0.11 per share in 2001 to a profit of $0.89 in 2005. Based on these forecasts,
Ted targeted a $1.80 per share stock price by the end of 2002, and
$18 by the end of 2005. That amounted to a tidy 3,000 percent gain in
four years, since the stock was then trading at only $0.48 per share.
Shoestring Operation
Obviously, Miracle Tech must have employed hordes of research
scientists and technicians to manage the simultaneous development
of those impressive products. Here’s the real miracle: Miracle
Tech was doing the whole job with a staff of only 10 full-time, and two
part-time employees, toiling away in a 5,000 square foot facility that it
had rented for $2,000 per month.
I’m not sure how Miracle Tech managed to pay even that meager
staff since, as of July 31, 2001, it had only $8,000 in the bank and its
debts far exceeded its assets.
With an empty bank account, Miracle Tech must have been
cranking up sales. But that wasn’t happening. Miracle Tech’s total sales
in the previous 12 months totaled a flat zero. Nothing!
I checked up on Miracle Tech again in March 2002, when I was
writing this article. By that time the firm’s October 2001 quarterly report
had been filed with the SEC. The company, with its stock now
trading at 30 cents, still hadn’t sold a dime’s worth of products. But it
had managed to burn through $767,000 in the quarter, mostly on consulting
fees.
Miracle Tech may not have sold anything, but it had been busy
cranking out press releases.
On November 6, 2001, Miracle Tech announced a partnership
with a Chinese company based in Singapore to market Miracle Tech’s
products. The two companies seemed most excited about Miracle
Tech’s magnetic pipe joining technology.
On December 18, Miracle Tech announced the formal opening
of its Beijing office, mentioned its new partnership with the Chinese
company, referring to it as a “hugely significant step.”
On January 30, 2002, Miracle Tech announced an agreement
with a unit of the Chinese government to investigate and develop Miracle
Tech’s magnetic pipe joining technology.
On February 11, 2002 Miracle said that it was in discussions with
a major Middle-Eastern gas producer regarding its pipe joining process.
I suppose that it’s theoretically possible for Miracle Tech and its
shareholders to hit the jackpot with one of their projects. However,
most companies developing products as sophisticated as Miracle
Tech’s, spend tens of millions of dollars, and employ staffs numbering
into the thousands.
Hyping Pays Well
How come Ted Touter didn’t see what I saw? What about all that
careful research that Ted promised in his email? Reading the disclaimer
at the end of Ted’s report revealed that Miracle Tech paid him to prepare
and mail the report, in this case, 100,000 shares of Miracle Tech stock.
It’s legal for Ted to promote Miracle Tech and to get paid for it as long
as he reveals the payments in the document and confesses that Miracle
Tech, in truth, supplied his so-called research.
Companies like Miracle Tech hire people like Ted to create investor
interest, moving the stock price up, and equally important, increasing
the trading volume, thereby allowing insiders to dump their
holdings. This process is known as pump and dump.
Quick Hype Checks
It’s understandable that investors get taken-in by promoters
like Ted. It’s everybody’s dream to get in on the ground floor of the
next big thing.
But many of the stocks you hear about from people that you
don’t know are not real businesses. They’re just shells organized to sell
stock to gullible investors.
Here are some simple checks you can run to spotlight the Miracle
Techs of the world so that you don’t waste time researching, or
worse, buying them.
You can find everything you need on almost any major financial
site. I’ll use Yahoo’s Profile report to illustrate the process. Get a quote
on Yahoo, select Profile, and scroll past the top section containing the
business summary to Statistics at a Glance to find the data.
PRICE
Many professional investors shun stocks trading at prices below
$5 per share. However, scores of fallen angel tech stocks were still trading
in the $2 to $5 range in early 2002. So $1 would have been a reasonable
minimum acceptable share price in that market. Miracle Tech’s
$0.30 share price flunked.
MARKET CAPITALIZATION
Minimum: $50 million
Market cap is the total value of a company (shares out multiplied
by the share price). Larger companies are considered safer investments
than smaller companies, and those with market caps below $100 million
or so are considered too risky by many investors. You will avoid most
pump and dump stocks by staying above $50 million. Miracle Tech’s $9
million market cap would have easily disqualified it in that category.
PRICE/BOOK RATIO
Maximum: 25
P/B (share price divided by stockholders’ equity) is the appropriate
value gauge when a company has neither sales nor earnings.
TTM SALES
Minimum: $40 million
A hallmark of pump and dump stocks is little or no sales. Most
companies worth considering rack up annual sales exceeding $40 million,
so avoid companies below that level. As mentioned earlier, Miracle
Tech’s annual sales totaled zero.
CURRENT RATIO
Minimum: 0.6
Current ratio, a comparison of a company’s assets to its current
debts, is a good measure of a company’s financial condition. A current
ratio of 1.0 or higher is considered safe, but some very solid companies
operate with lower ratios in the 0.7 to 1.0 range. Avoid companies with
current ratios below 0.6. When I checked, Miracle Tech’s current ratio
was 0.3.
Summary
Thousands of U.S. traded companies meet all five of these requirements.
You can avoid these risky bets by requiring your candidates
to meet at least four of the five. | 
Disclaimer
