One of the risks in trading penny stocks is the lack of verified and publicly disclosed information, especially for those trading on pink sheets or OTC bulletin boards. Unlisted stocks don’t have to disclose the same type and amount of information that those on the exchanges do.
In addition, a lot of penny stock companies are new. They don’t have a track record or financial history to evaluate, leaving you pretty much in the dark about their quality and fundamentals.
That leaves traders and speculators turning to penny stock newsletters and paid ads, which happen to also be the preferred sources for penny stock scammers to launch their schemes. In fact, the SEC specifically warns investors of the following types of common penny stock fraud:
- Emails spreading false information about a microcap
- Fraudsters using aliases to post on investor bulletin boards, chat rooms, and websites, promising “insider information” about a penny stock
- Paid promoters that act as unbiased analysts or experts in newsletters, radio, and TV shows to push up interest in a penny stock on behalf of a scammer
- Cold calling, which is a common technique with offshore brokers who track in unregistered penny stocks in increasingly common offshore scams
- False press releases disseminated through legitimate news sources
In other words, you have to treat every bit of information you see or hear about a penny stock from an unverified source as suspect, and the first act of a pump and dump scheme.
Ultimately, you have to be a bit of a sleuth to get actual, verified, useful information about penny stocks. It will take time, but the information you gather on your own from verified sources is the only information you can trust.
All firms trading on the major exchanges and on the OTCBB exchange (but not the pink sheets) are required to file financials with the SEC or their bank or insurance regulator. Most file electronically with the SEC. which maintains a database known as EDGAR to track and view them. You can visit the SEC website (http://www.sec.gov) and search for financial filings on any listed penny stocks you’re interested in.
If the company doesn’t file with the SEC, you can contact the state securities regulator in the state in which it’s headquartered for company information. The Secretary of State may also be able to provide copies of annual reports the company files with the state.
Banking companies don’t file with the SEC, but they do have to file with banking regulators. If the penny stock company is a bank, visit the FDIC website (http://www.FDIC.gov) to find updated financial information.
Commercial databases such as Hoover’s, Dun & Bradstreet, Bloomberg, and Standard & Poor’s may contain useful information such as the company’s management, business lines, and revenue.
Be sure you understand exactly what the company does and how it makes its money, and watch out for red flags such as:
- Trading suspensions by the SEC. These occur when the SEC believes information about a company is inaccurate or false.
- High assets but low revenue. Penny stock companies often inflate the value of assets that have no legitimate connection to their business.
- Footnotes in the financial statements documenting unusual transactions such as loans or assets-for-stock swaps.
- High percentage of insider ownership, or high ownership by a single entity. This makes it much easier to manipulate the price and profit off a pump and dump scheme.
Reject any companies you can’t find financial information on. Penny stocks are risky enough when you have some idea of the underlying company’s finances and structure; without that information, they are not worth the risk.