Microcap Stock: A Guide for Investors

For those who are new to microcap stocks, here is the guide from the U.S. Securities and Exchange Commission (also known as the SEC). Please read more carefully on the Risk section, and the fraud schemes section. And as always, make sure you know what you are doing when dealing with the market.

Herewith, I quoted some information from the SEC site.

Introduction

Information is the investor's best tool when it comes to investing wisely. But accurate information about "microcap stocks" — low-priced stocks issued by the smallest of companies — may be difficult to find. Many microcap companies do not file financial reports with the SEC, so it's hard for investors to get the facts about the company's management, products, services, and finances. When reliable information is scarce, fraudsters can easily spread false information about microcap companies, making profits while creating losses for unsuspecting investors.
In the battle against microcap fraud, the SEC has toughened its rules and taken actions against wrongdoers, but we can't stop every microcap fraud. We need your help in winning the battle. Before you consider investing in a microcap company, arm yourself first with information. This alert tells you about microcap stocks, how to find information, what "red flags" to consider, and where to turn if you run into trouble.

What Is a Microcap Stock?

The term "microcap stock" applies to companies with low or "micro" capitalizations, meaning the total value of the company's stock. Microcap companies typically have limited assets. For example, in cases where the SEC suspended trading in microcap stocks, the average company had only $6 million in net tangible assets — and nearly half had less than $1.25 million. Microcap stocks tend to be low priced and trade in low volumes.

Where Do Microcap Stocks Trade?

Many microcap stocks trade in the "over-the-counter" (OTC) market and are quoted on OTC systems, such as the OTC Bulletin Board (OTCBB) or the "Pink Sheets."

• OTC Bulletin Board The OTCBB is an electronic quotation system that displays real-time quotes, last-sale prices, and volume information for many OTC securities that are not listed on the Nasdaq Stock Market or a national securities exchange. Brokers who subscribe to the system can use the OTCBB to look up prices or enter quotes for OTC securities. Although the NASD oversees the OTCBB, the OTCBB is not part of the Nasdaq Stock Market. Fraudsters often claim that an OTCBB company is a Nasdaq company to mislead investors into thinking that the company is bigger than it is.

• The "Pink Sheets" The Pink Sheets — named for the color of paper on which they've historically been printed — are listings of price quotes for companies that trade in the over-the-counter market (OTC market). "Market makers" — the brokers who commit to buying and selling the securities of OTC issuers-can use the pink sheets to publish bid and ask prices. A company named Pink Sheets LLC, formerly known as the National Quotation Bureau, publishes the pink sheets in both hard copy and electronic format. Pink Sheets LLC is not registered with the SEC as a stock exchange, nor does the SEC regulate its activities.

How Are Microcap Stocks Different From Other Stocks?

Lack of Public Information The biggest difference between a microcap stock and other stocks is the amount of reliable, publicly available information about the company. Larger public companies file reports with the SEC that any investor can get for free from the SEC's website. Professional stock analysts regularly research and write about larger public companies, and it's easy to find their stock prices in the newspaper. In contrast, information about microcap companies can be extremely difficult to find, making them more vulnerable to investment fraud schemes.

No Minimum Listing Standards Companies that trade their stocks on major exchanges and in the Nasdaq Stock Market must meet minimum listing standards. For example, they must have minimum amounts of net assets and minimum numbers of shareholders. In contrast, companies on the OTCBB or the Pink Sheets do not have to meet any minimum standards.

Risk While all investments involve risk, microcap stocks are among the most risky. Many microcap companies tend to be new and have no proven track record. Some of these companies have no assets or operations. Others have products and services that are still in development or have yet to be tested in the market. Another risk that pertains to microcap stocks involves the low volumes of trades. Because microcap stocks trade in low volumes, any size of trade can have a large percentage impact on the price of the stock.

Microcap fraud schemes

Microcap fraud schemes can take a variety of forms. Here's a description of the most common schemes:

The Classic "Pump and Dump" Scheme It's common to see messages posted on the Internet that urge readers to buy a stock quickly or to sell before the price goes down, or a telemarketer will call using the same sort of pitch. Often the promoters will claim to have "inside" information about an impending development or to use an "infallible" combination of economic and stock market data to pick stocks. In reality, they may be company insiders or paid promoters who stand to gain by selling their shares after the stock price is pumped up by the buying frenzy they create. Once these fraudsters sell their shares and stop hyping the stock, the price typically falls, and investors lose their money.

The Latest Variation of the "Pump and Dump" Scheme
Some people are finding that they have received a "misdialed" call from a stranger, leaving a "hot" investment tip for a friend. The message is designed to sound as if the speaker didn't realize that he or she was leaving the hot tip on the wrong answering machine. If you get a message like this, it's not a wrong number at all. Instead, it is from someone who is being paid to leave these messages on a whole lot of answering machines. Check out "Wrong Numbers" and Stock Tips on Your Answering Machine for more information and to hear one of these scams.

The Off-Shore Scam Under a rule known as "Regulation S," companies do not have to register stock they sell outside the United States to foreign or "off-shore" investors. In the typical off-shore scam, an unscrupulous microcap company sells unregistered Reg S stock at a deep discount to fraudsters posing as foreign investors. These fraudsters then sell the stock to U.S. investors at inflated prices, pocketing huge profits that they share with the microcap company insiders. The flood of unregistered stock into the U.S. eventually causes the price to plummet, leaving unsuspecting U.S. investors with enormous losses.

What if I Want to Invest in Microcap Stocks?

To invest wisely and avoid investment scams, research each investment opportunity thoroughly and ask questions. These simple steps can make the difference between profits and losses:

1. Find out whether the company has registered its securities with the SEC or your state's securities regulators.
2. Make sure you understand the company's business and its products or services.
3. Read carefully the most recent reports the company has filed with its regulators and pay attention to the company's financial statements, particularly if they are not audited or not certified by an accountant. If the company does not file reports with the SEC, be sure to ask your broker for what's called the "Rule 15c2-11 file" on the company. That file will contain important information about the company.
4. Check out the people running the company with your state securities regulator, and find out if they've ever made money for investors before. Also ask whether the people running the company have had run-ins with the regulators or other investors.
5. Make sure the broker and his or her firm are registered with the SEC and licensed to do business in your state. And ask your state securities regulator whether the broker and the firm have ever been disciplined or have complaints against them.

Successful Investing (Part 3 - Knowledge)

In my previous article titled Successful Investing Part 1 and Part 2, I covered five things that you will need to be successful in investing. They are passion, common sense, opportunity, strategy and capital. Here is the last piece of the puzzle: Knowledge.

6. Knowledge
My friend once told me that "Knowledge is King"

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This section is still under construction
Thanks for visiting. Check back soon,

Sidarta Tanu

ETLT.OB: An example of a value microcap stock

Fellow Investors,

I have mentioned before that I will try not to mention any particular stock as I don’t want to be seen as impacting (i.e. pumping) the stock price in any way, but let me give one example of a value microcap stock to supplement the Successful Investing article series.

Eternal Technologies (ETLT.OB)
Market Cap: $20M-$22M
Share price: $0.50-.$0.56 (5 days range)
Diluted outstanding: 40M shares
Preferred outstanding: 0
Cash: $30M+ (restricted cash)
Debt: $0
Earning: $4M+ (and has been profitable for many years)
Retained earnings: $35M
Sales: $23M
PE = 5
P/tangible book < 1

Their business is agriculture (low tech stuff such as farming and husbandry business, and breast cancer detection business). I am predicting that they want to be a conglomerate (diverse business). Check out their 10Qs and 10Ks. ETLT business is located in China (and Asia), which I think is one of the reasons why the stock priced as it is today (fraud risk, corruption risk and emerging market risk), and also the restricted cash status.

Disclosure:
I own this stock in my portfolioI am not recommending anyone to buy or not to buy this stock.
Bulletin board stocks are usually very risky, volatile and thinly traded and not suited for many investors (and definitely not suitable for short term trade.)
I will not disclose my price target price or what I think they should worth today as I just want to give an (unbiased) example of a value microcap stock.
However, I welcome anyone who have any question (or want to discuss) about the value microcap topic or ETLT business/current valuation (statistics that I mentioned above).

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This is in a supplement to my Successful Investing article series. Check out the part 2 of the article.

Thank you for your interest,

Sidarta Tanu

Successful Investing (Part 2 - Opportunity, Strategy and Capital)

In my previous article titled Successful Investing Part 1, I covered two things that you will need to be successful in investing. They are passion and common sense. These two are the most crucial and fundamental things that you will need to have and to continually improve wherever possible.

The next three things that you will need to be successful in investing are: opportunity, strategy and capital.


3. OPPORTUNITY (and the ability to identify the opportunity)

There are many opportunities out there and we need to be able to identify those opportunities to be successful in investing. First, we need to figure out what our circle of competence is. Basically, what area do we know more than common people (or the average). Make sure our assessment is accurate about our circle of competence. Those area can be general or specific but the higher the level of expertise and the more accurate the assessment is, the more useful the circle of competence is. I happen to choose a broad circle of competence which is the microcap capitalization companies (and I try to increase my expertise in this area through other people experience and my own experience). But there are many areas (with it's sub-categories) that you can choose to focus on such as:

- Capitalization (Large, Medium, Small, Micro)
- Industry (Oil and Gas, Healthcare, Technology, Internet, Consumer products, Biotechnology, Banking, Marketing, Consulting, Service, Metal, Currency, Commodities, etc.)
- Asset Classification (Common equity, Convertible debentures, Commercial Paper, Bonds, Mortgage backed securities, Treasury, Money market etc.)

And you might ask what could be considered a good circle of competence. Here are some of the examples that one needs to know (about a particular company, industry, capitalization or asset classifications):

- What the company/industry produces
- Who are the players (and the leaders)
- Who are the users/consumers
- What drives supply and demand (and the elasticity)
- What are the criteria to survive (and excel)
- What is the best and worst case scenario (and the triggers)
- How the change in economy cycle will impact this area
- How the profit is made
- How is the balance sheet
- How far leverage is used and whether capital is used efficiently
- How's the quality and integrity of those who run the business
- What are the Porter 5 forces analysis for this area (related to competition threat and substitute products)

Once you know what your circle of competence is, try to stay within the circle of competence. Of course as times go by your circle of competence can change/expand your circle of competence where you will be able to spot opportunity in new areas. A lot of times, an opportunity is not open for too long as many other people are also lurking around trying to capitalize on these opportunities, and if you miss the opportunity, don't force or chase it. As I mentioned earlier, there are many opportunities out there everyday. This is also called strategy which is the next topic.


4. STRATEGY (and the discipline to follow the strategy)

Let's say that you have identified a perfect opportunity, now you will need a strategy to realize the benefit of the opportunity. Just like a famous saying in Wall Street that bull makes money, bears makes money but pig gets slaughtered, we need a sound strategy so we won't be the pig of Wall Street. There are many strategies that you can adopt and usually if we analyze and optimize our strategy correctly, the risk that we take will correlate with the potential return that we will get (except on perfectly risk-free or arbitrage opportunities which nowadays aren't too many out there). Some of the strategies that one should think about carefully before executing any transaction:

- Long or Short position
- Long term or Short term holding period
- Common stock or derivatives (option, futures, forwards)
- Investment style (speculation, growth, income, capital preservation, hedging, or hybrid)
- Asset allocation (portfolio management, percentage of asset class)

I strongly believe that whichever strategy (or combination of strategies) that we choose, as long as we are diligent and good at it, we will be succesful. Again, as I mentioned earlier, knowing what will impacts this strategy and how to make this particular strategy work is important. Once we find our sweet spot , we need to be discipline to stick with it and resist temptation to execute transaction outside our strategy (this usually happens when we are already/recently successful and feel invincible).

Creating a strategy that works is more art than science. There is no one size fits all strategy. Learning from other's experience, and experiencing ourself (trial and error) could be one way to help us formulate our strategy. In the end, you want to feel comfortable (and know the ins and out) and confident with the strategy that you choose. My strategy is long term hold common equity (growth equity with potential income in the future), and so far it has been working for me and I'm planning to stick with it. I found out about this after doing a lot of trial and error (and losing a lot of real money in the process which is not a necessary requirement . Fortunately I found a strategy that works for me in the process, so it is not all wasted). Once you have the opportunity and streategy, you will need capital before you can join the action.


5. CAPITAL (and I don't mean debt or margin)

It should be a common sense that it takes money to make money. Although I understand the potential benefit of using leverage, in my opinion, we should our own money in Investing (at least to begin with). A lot of people (such as Robert Kiyosaki and Michael Lecther) advocates the usage of other people's money (OPM) to make money, but borrowing money to invest in stocks (the heavy usage of margin) is generally riskier compared to borrowing money to buy a house or grow your well established business (to some extent). Sometime, I think those who recommend people to borrow money (without explaining the risk related to it) are trying to attract those who wants an easy way out. In general, I would recommend people use their own hard-earned money to invest because from my experience, they will be more careful about investing it (and do all the due diligence needed). Once we become an expert (and know all the risk), then we can use some leverage to try to increase your return. And for those who don't have the capital to invest yet, please do start saving some money now.


Once we have opportunity, strategy, and capital, we are ready to invest successfully.
Next, I will mention one other area that can help improve our circle of competence and strategy.

Part 3 - to be continued...