Wednesday, April 7, 2010

Avoiding Stock Market Scams

We have recently discussed a couple of companies that don't trade on the major exchanges (e.g. the NYSE, the Nasdaq etc). Though it has been mentioned that over-the-counter stocks do not offer investors the same protections as do stocks trading on the exchanges, the details were not explored. However, there are some "smell tests" investors may wish to apply to such apparent opportunities.

Consider NewMarket Technology (NWMT), a company that provides a range of technology-based services. The company has total assets of $53 million, and has net current assets of $12 million. However, the company trades for just a couple of hundred thousand dollars! For a company with $100 million in sales, how can this be?

It is possible that the company is not a scam at all, but just a victim of poor management. The company has issued several rounds of preferred shares, which are convertible to common stock. The conversion rates are extremely dilutive, resulting in the issuance of millions of shares that flood the market with this company's stock. Investors who believe this company to be legit should beware of further stock issuances, as convertible preferred stock remains outstanding.

But upon further investigation, there may be more to this story than the idea that this is simply an undervalued stock undergoing a flurry of dilution. While the company claims to have "over 600 employees" and its "target markets are located domestically in all 50 states", it is very difficult to pinpoint from where the company runs its operations. It's impossible to reach anyone by phone at the company's headquarters, as calls to the company's two provided numbers repeatedly went unanswered! E-mail and phone requests to the company's investor relation's department were also ignored.

Public companies are required to have independent auditors, which provide some form of comfort to investors. But this company has gone through several auditors in the past few years, each of which appears to have little in the way of name recognition but much in the way of legal issues. The auditor of the company's 2008 financial statements is now barred from practice, as per these findings of the SEC. The newest auditor is a two-person, husband and wife tandem who appear to operate out of their own home, for this a $100 million, international company!

But while it may be impossible to speak with any of the company's employees, the company doesn't hesitate to publish schools of positive press releases to pump the company's stock, including this laughable video, put together by a really professional outfit:

It's important that it be re-iterated that it's not clear that NewMarket is a scam. But it's never clear whether a company is acting fraudulently. Investors in companies that trade over-the-counter must take special steps to ensure the investment is legitimate, since the added layer of protection added by the major exchanges is absent. Since the #1 principle of value investing is "Never Lose Money", companies that don't pass these basic tests should be discarded.

Disclosure: None

This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.


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