Pink Sheets & Lipsticked Pigs
Given the volatility that has come upon the stock and bond markets in recent weeks, I would like to share with you a few tips that have served me well:
First and foremost, never let your emotions determine your actions. Use information and intellect. While markets can behave in illogical ways, there is usually a reason. While your gut feeling or emotions may be right, it is more often wrong. Many algorithms used by professional traders factor in illogical actions by retail investors in an attempt to profit from that behavior.
Avoid most real estate investment trusts (REITs). Have you ever read one of their prospectuses? The large dividends that most REITs pay are actually a return of your principal that you then get to pay taxes on. Ever hear of the term, ‘putting lipstick on a pig’? That is what those dividends are for many REITs.
Avoid micro-cap stocks. Micro-caps have $1 billion or less in a market capitalization and should be avoided because that the pool of buyers is smaller, meaning that a stock price can fall very quickly for no reason whatsoever or due to the actions of only a few shareholders.
The daily volumes for any stock that you own need to be high enough to support a tight bid-ask spread. Restated in English, there should be many buyers and sellers of any stock that you own. One thing that is a good indication that the stock has many buyers and seller is a narrow range between the price that someone will sell the stock at and the price that someone will buy it at. If a spread is only a penny or two, that would suggest that there are many buyers and sellers.
Never own penny stocks. A penny stock is any stock under $5.00. Daily volumes are typically controlled by a few large holders with far better information on the company than you.
Never own a pink sheet stock. Period. Pink sheets typically do not have audited financial statements and many never report financials. How can you invest in something when you do not know its financial condition?
Something that often happens with pink sheet and penny stocks is the ‘the dead cat bounce’ - the stock price briefly goes up after a steep decline only to continue its descent. The cause of a dead bounce is typically a mix of speculators covering their positions and casual investors incorrectly sensing a bottom.
This brings up a very important lesson when investing that applies to everyday life…
Never try to catch a falling knife as you might get cut. Investors with inadequate knowledge as to the reasons for the decline often get cut when sensing a bottom.
Sometimes the best thing that you can do is nothing.
The best way to beat the professional traders is to buy stocks to hold long-term. Next week is a long time to many professional trading firms. As such, you have the advantage of time.
This last tip is probably the best one that few advisors will ever tell you: when seeking out investment advice, find an investment advisor who is also a fiduciary. An investment advisor who is also a fiduciary is your best chance to get advice that is not biased by the size of the commission check that the broker/advisor can get from selling you that mutual fund, annuity, private placement, hedge fund or other commission-heavy product. Fiduciaries must put your best interest ahead of their interest or that fiduciary and their firm can get in big trouble.
As many advisors will say that they are fiduciaries when they are not, get their statements in writing. Only 6% of all investment advisors are fiduciaries and virtually none are brokers.
Haddon Libby is the Founder and Managing Partner of Winslow Drake Investment Management and can be reached at HLibby@WinslowDrake.com.