Tag Archives: david-merkel

Stocks That Can Double, Can Give You Trouble

Summary Every day, around 45 stocks double or more in price. That may be true, but most of those that do double or more in price don’t do so for fundamental reasons; they are often manipulated. Second, the stocks that do double in price can’t be found in advance – i.e., picking the day that the price will explode. Third, the prices more often fall hard for these tiny stocks. Fourth, for the few that rise a lot, you can’t invest in them. I haven’t written about promoted penny stocks in a long time . Tonight, I am not writing about promoted stocks, only penny stocks as promoted by a newsletter writer . He profits from the newsletter. Ostensibly, he does not front-run his readers. Before we go on, let me run the promoted stocks scoreboard: Ticker Date of Article Price @ Article Price @ 12/1/15 Decline Annualized Dead? ( OTCPK:GTXO ) 5/27/2008 2.45 0.011 -99.6% -51.5% ( OTCPK:BONZ ) 10/22/2009 0.35 0.000 -99.9% -68.5% ( OTCPK:BONU ) 10/22/2009 0.89 0.000 -100.0% -100.0% ( OTC:UTOG ) 3/30/2011 1.55 0.000 -100.0% -100.0% Dead (OBJE) 4/29/2011 116.00 0.000 -100.0% -100.0% Dead ( OTCPK:LSTG ) 10/5/2011 1.12 0.004 -99.6% -74.2% ( OTC:AERN ) 10/5/2011 0.0770 0.0001 -99.9% -79.8% ( OTC:IRYS ) 3/15/2012 0.261 0.000 -100.0% -100.0% Dead ( OTCPK:RCGP ) 3/22/2012 1.47 0.180 -87.8% -43.4% ( OTCQB:STVF ) 3/28/2012 3.24 0.070 -97.8% -64.7% ( OTCPK:CRCL ) 5/1/2012 2.22 0.001 -99.9% -87.2% ( OTCPK:ORYN ) 5/30/2012 0.93 0.001 -99.9% -85.4% ( OTCQB:BRFH ) 5/30/2012 1.16 1.000 -13.8% -4.1% ( OTCPK:LUXR ) 6/12/2012 1.59 0.002 -99.9% -86.3% ( OTCQB:IMSC ) 7/9/2012 1.5 0.495 -67.0% -27.9% ( OTCPK:DIDG ) 7/18/2012 0.65 0.000 -100.0% -100.0% ( OTCQB:GRPH ) 11/30/2012 0.8715 0.013 -98.5% -75.4% ( OTCPK:IMNG ) 12/4/2012 0.76 0.012 -98.4% -75.0% ( OTCPK:ECAU ) 1/24/2013 1.42 0.000 -100.0% -94.9% ( OTCPK:DPHS ) 6/3/2013 0.59 0.005 -99.2% -85.5% ( OTC:POLR ) 6/10/2013 5.75 0.005 -99.9% -94.2% ( OTC:NORX ) 6/11/2013 0.91 0.000 -100.0% -97.5% ( OTCQB:ARTH ) 7/11/2013 1.24 0.245 -80.2% -49.3% ( OTCPK:NAMG ) 7/25/2013 0.85 0.000 -100.0% -100.0% ( OTCPK:MDDD ) 12/9/2013 0.79 0.003 -99.7% -94.5% ( OTCPK:TGRO ) 12/30/2013 1.2 0.012 -99.0% -90.9% ( OTCQB:VEND ) 2/4/2014 4.34 0.200 -95.4% -81.6% (HTPG) 3/18/2014 0.72 0.003 -99.6% -95.9% ( OTCQB:WSTI ) 6/27/2014 1.35 0.000 -100.0% -99.9% (APPG) 8/1/2014 1.52 0.000 -100.0% -99.8% (CDNL) 1/20/2015 0.35 0.035 -90.0% -93.1% 12/1/2015 Median -99.9% -87.2% If you want to lose money, it is hard to do it more consistently than this. No winners out of 31, and only one company looks legit at all – Barfresh ( OTCQB:BRFH ). But what of the newsletter writer? He seems to have a couple of stylized facts that are misapplied. Every day, around 45 stocks double or more in price. Some wealthy investors have bought stocks like these. Wall Street firms own these stocks but never recommend them to ordinary individuals The media censors price information about these stocks so you never hear about them Every day, around 45 stocks double or more in price. That may be true, but most of those that do double or more in price don’t do so for fundamental reasons; they are often manipulated. Second, the stocks that do double in price can’t be found in advance – i.e., picking the day that the price will explode. Third, the prices more often fall hard for these tiny stocks. Of the 30 stocks mentioned above that were not dead at the time of the last article, 10 fell more than 90% over the 10+ month period. 13 fell less than 90%, 1 broke even, and 7 rose in price. The median stock fell 61%. This was during a bull market. Now you might say, “Wait, these are promoted stocks, of course they fell.” Only the last one was being actively promoted, so that’s not the answer. My fourth point is for the few that rise a lot, you can’t invest in them. The stocks that double or more in a day tend to be the smallest of the stocks. Two of the 30 stocks listed in the scoreboard rose 900% and 7100% in the 10+ month period since my last article. How much could you have invested in those stocks? You could have bought both companies for a little more than $10,000 each. Anyone waving even a couple hundred bucks could make either stock fly. So, no, these stocks aren’t a road to riches. Now the ad has stories as to how much money people made at some point buying the penny stocks. The odds of stringing several of these successful purchases in succession, parlaying the money into bigger and bigger stocks that double is remote at best, and your odds of losing a lot of it is high. This idea is a less classy version of the idea promoted in the book 100 to 1 in the Stock Market . If it is difficult to find the 100-baggers 30 years in advance, it is more difficult to find a stock that is going to double or more tomorrow, much less a bunch of them in succession. You may as well go to Vegas and bet it all on Double Zero on the roulette wheel four times in a row. The odds are about that bad, as trying to get rich buying penny stocks. The ad also lists three stock that at some point fit his paradigm – MeetMe (NASDAQ: MEET ), PlasmaTech Biopharmaceuticals, Inc. (PTBI), which is now called Abeona Therapeutics Inc. (NASDAQ: ABEO ), and Organovo (NYSEMKT: ONVO ). All of these are money-losing companies (MeetMe may be breaking into profitability now) that have survived by selling shares to raise cash. The stocks have generally been poor. Have they had volatile days where the price doubled? At some point, probably, but who could have picked the date in advance, and found liquidity to do a quick in-and-out trade? The author lists five future situations as a “come on” to get people to subscribe. I find them dubious. As for wealthy investors, he mentions two: Icahn pulling of a short squeeze on Voltari (difficult to generalize from), and Soros with PlasmaTech Biopharmaceuticals, Inc. It should be noted that Soros has a big portfolio with many stocks, and that position was far less than 1% of his assets. In general, the wealthy do not buy penny stocks. As for brokers and the media not mentioning penny stocks, that is being responsible. The brokers could get in hot water for recommending or buying penny stocks even under a weak suitability standard. The media also does not want to be blamed for inciting destructive speculation. Retail investors lose enough money through uninformed trading, why encourage them to do it where fundamentals are typically quite poor. I’ve written two other pieces on less liquid stocks to try to explain the market better: On Penny Stocks and Good Over-the-Counter “Pink” Stocks . It’s not as if there isn’t value in some of the stocks that “fly under the radar.” That said, you have to be extra careful. Near the end of the ad, the writer describes how he is being extra careful also. Many of his rules make a lot of sense. That said, following those rules will get you boring companies that won’t double or more in a day. And that’s not a bad thing. Most significant money is made slowly – it doesn’t come in a year, much less in a day. That said, I recommend against the newsletter because of the way that it tries to attract people. The rhetoric is over the top, and appeals to those who sense conspiracies keeping them from riches, so join my club where I hand out my secret knowledge so you can benefit. In summary, as a first approximation, don’t invest in penny stocks. The odds are against you. Fools rush in where angels fear to tread. Don’t let greed get the better of you – after all, what is being illustrated is an illusion that retail investors can’t generally achieve. Disclosure: None

Notes On The SEC’s Proposal On Mutual Fund Liquidity

I’m still working through the SEC’s proposal on Mutual Fund Liquidity, which I mentioned at the end of this article : Q: Are you going to write anything regarding the SEC’s proposal on open end mutual funds and ETFs regarding liquidity ? A: …my main question to myself is whether I have enough time to do it justice. There’s their white paper on liquidity and mutual funds . The proposed rule is a monster at 415 pages , and I may have better things to do. If I do anything with it, you’ll see it here first. These are just notes on the proposal so far. Here goes: 1) It’s a solution in search of a problem. After the financial crisis, regulators got one message strongly – focus on liquidity. Good point with respect to banks and other depositary financials, useless with respect to everything else. Insurers and asset managers pose no systemic risk, unless like AIG they have a derivatives counterparty. Even money market funds weren’t that big of a problem – halt withdrawals for a short amount of time, and hand out losses to withdrawing unitholders. The problem the SEC is trying to deal with seems to be that in a crisis, mutual fund holders who do not sell lose value from those who are selling because the Net Asset Value at the end of the day does not go low enough. In the short run, mutual fund managers tend to sell liquid assets when redemptions are spiking; the prices of illiquid assets don’t move as much as they should, and so the NAV is artificially high post-redemptions, until the prices of illiquid assets adjust. The proposal allows for “swing pricing.” From the SEC release : The Commission will consider proposed amendments to Investment Company Act rule 22c-1 that would permit, but not require, open-end funds (except money market funds or ETFs) to use “swing pricing.” Swing pricing is the process of reflecting in a fund’s NAV the costs associated with shareholders’ trading activity in order to pass those costs on to the purchasing and redeeming shareholders. It is designed to protect existing shareholders from dilution associated with shareholder purchases and redemptions and would be another tool to help funds manage liquidity risks. Pooled investment vehicles in certain foreign jurisdictions currently use forms of swing pricing. A fund that chooses to use swing pricing would reflect in its NAV a specified amount, the swing factor, once the level of net purchases into or net redemptions from the fund exceeds a specified percentage of the fund’s NAV known as the swing threshold. The proposed amendments include factors that funds would be required to consider to determine the swing threshold and swing factor, and to annually review the swing threshold. The fund’s board, including the independent directors, would be required to approve the fund’s swing pricing policies and procedures. But there are simpler ways to do this. In the wake of the mutual fund timing scandal, mutual funds were allowed to estimate the NAV to reflect the underlying value of assets that don’t adjust rapidly. This just needs to be followed more aggressively in a crisis, and peg the NAV lower than they otherwise would, for the sake of those that hold on. Perhaps better still would be provisions where exit loads are paid back to the funds, not the fund companies. Those are frequently used for funds where the underlying assets are less liquid. Those would more than compensate for any losses. 2) This disproportionately affects fixed income funds. One size does not fit all here. Fixed income funds already use matrix pricing extensively – the NAV is always an estimate because not only do the grand majority of fixed income instruments not trade each day, most of them do not have anyone publicly posting a bid or ask. In order to get a decent yield, you have to accept some amount of lesser liquidity. Do you want to force bond managers to start buying instruments that are nominally more liquid, but carry more risk of loss? Dividend-paying common stocks are more liquid than bonds, but it is far easier to lose money in stocks than in bonds. Liquidity risk in bonds is important, but it is not the only risk that managers face. it should not be made a high priority relative to credit or interest rate risks. 3) One could argue that every order affects market pricing – nothing is truly liquid. The calculations behind the analyses will be fraught with unprovable assumptions, and merely replace a known risk with an unknown risk. 4) Liquidity is not as constant as you might imagine. Raising your bid to buy, or lowering your ask to sell are normal activities. Particularly with illiquid stocks and bonds, volume only picks up when someone arrives wanting to buy or sell, and then the rest of the holders and potential holders react to what he wants to do. It is very easy to underestimate the amount of potential liquidity in a given asset. As with any asset, it comes at a cost. I spent a lot of time trading illiquid bonds. If I liked the creditworthiness, during times of market stress, I would buy bonds that others wanted to get rid of. What surprised me was how easy it was to source the bonds and sell the bonds if you weren’t in a hurry. Just be diffident, say you want to pick up or pose one or two million of par value in the right context, say it to the right broker who knows the bond, and you can begin the negotiation. I actually found it to be a lot of fun, and it made good money for my insurance client. 5) It affects good things about mutual funds. Really, this regulation should have to go through a benefit-cost analysis to show that it does more good than harm. Illiquid assets, properly chosen, can add significant value. As Jason Zweig of the Wall Street Journal said : The bad news is that the new regulations might well make most fund managers even more chicken-hearted than they already are – and a rare few into bigger risk-takers than ever. You want to kill off active managers, or make them even more index-like? This proposal will help do that. 6) Do you want funds to limit their size to comply with the rules, while the fund firm rolls out “clone” fund 2, 3, 4, 5, etc? You will never fully get rid of pricing issues with mutual funds, but the problems are largely self-correcting, and they are not systemic. It would be better if the SEC just withdrew these proposed rules. My guess is that the costs outweigh the benefits, and by a wide margin. Disclosure: None

When To Double Down

Here is a recent question that I got from a reader: I have a question for you that I don’t think you’ve addressed in your blog. Do you ever double down on something that has dropped significantly beyond portfolio rule VII’s rebalancing requirements and you see no reason to doubt your original thesis? Or do you almost always stick to rule VII? Just curious. Portfolio rule seven is: Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes. This rule is meant to control arrogance and encourage patience. I learned this lesson the hard way when I was younger, and I would double down on investments that had fallen significantly in value. It was never in hopes of getting the whole position back to even, but that the incremental money had better odds of succeeding than other potential uses of the money. Well, that would be true if your thesis is right, against a market that genuinely does not understand. It also requires that you have the patience to hold the position through the decline. When I was younger, I was less cautious, and so by doubling down in situations where I did not do my homework well enough, I lost a decent amount of money. If you want to read those stories, they are found in my Learning from the Past series. Now, since I set up the eight rules, I have doubled down maybe 5-6 times over the last 15 years. In other words, I haven’t done it often. I turn a single-weight stock into a double-weight stock if I know: The position is utterly safe, it can’t go broke The valuation is stupid cheap I have a distinct edge in understanding the company, and after significant review, I conclude that I can’t lose Each of those 5-6 times I have made significant money, with no losers. You might ask, “Well, why not do that only, and all the time?” I would be in cash most of the time, then. I make decent money on the rest of my stocks as well on average. The distinct edge usually falls into the bucket of the market sells off an entire industry, not realizing there are some stocks in the industry that aren’t subject to much of the risk in question. It could be as simple as refiners getting sold off when oil prices fall, even though they aren’t affected much by oil prices. Or, it could be knowing which insurance companies are safe in the midst of a crisis. Regardless, it has to be a big edge, and a big valuation gap, and safe. The Sense of Rule Seven Rule Seven has been the rule that has most protected the downside of my portfolio while enhancing the upside. The two major reasons for this is that a falling stock triggers a thorough review, and that if I do add to my position, I do so in a moderate and measured way, and not out of any emotion. It’s a business, it is not a gamble per se. As a result, I have had very few major losses since implementing the portfolio rules. I probably have one more article to add to the “Learning from the Past Series,” and the number of severe losses over the past 15 years is around a half dozen out of 200+ stocks that I invested in. Summary Doubling down is too bold of a strategy, and too prone for abuse. It should only be done when the investor has a large edge, cheap valuation, and safety. Rule Seven allows for moderate purchases under ordinary conditions and leads to risk reductions when position reviews highlight errors. If errors are eliminated, Rule Seven will boost returns over time in a modest way, and reduce risk as well. Disclosure: None