For anyone looking to dabble in the tricky over-the-counter stock market, now might be a good time to start.
Frequently, prices of small OTC stocks hit a low at the end of December, when investors sell for tax reasons. Then, when the new year comes around, the stocks rebound, with many recording half their annual gains in January.
But don`t assume that the over-the-counter market is a quick way to make money. Though the market is good for small investors willing to do homework, it also has more than its share of pitfalls.
For one thing, ethics can be less rigid than among the better-policed stocks on the big exchanges.
And a few questionable brokers or market makers, dealers who in effect act as middlemen for a stock, can make prices of these little stocks rise or fall to suit their interests. Those could be quite different from the investor`s.
There is one compelling reason, however, to consider investing in small and obscure stocks despite the potential hazards. For here, among the smallest and least-known issues in the over-the-counter market, the small investor stands his best chance of making big profits.
That`s because companies this size are too small to interest institutional investors and big research departments, who rarely invest less than $500,000 at a clip. So, there is less competiton for the shares, and prices of the OTC stocks tend to be ”cheaper” in terms of potential earnings and growth than stocks of larger companies.
What`s more, when the little companies grow big enough to attract institutional buyers, the price of the shares will get an additional boost.
Over-the-counter stocks are simply the collection of public stocks–some 11,000 of them–that aren`t traded over a big stock exchange.
Some aren`t traded on an exchange because they are too small or their stock is too tightly controlled by one owner. Others elect not to be traded traded on an exchange.
Prices of some of these issues are quoted daily in newspapers through the National Association of Securities Dealers Automated Quotation System
(NASDAQ), but those are primarily the larger OTC stocks. Substantially more issues are quoted daily among brokers through a private price list known as the Pink Sheets.
Marc Reinganum, an associate professor of finance at the University of Southern California, has spent several years comparing stock market performance of the smallest stocks, in terms of total market capital, with the larger ones.
His findings: Small stocks, particularly the tiniest over-the-counter ones with market capital of less than $15 million when you add the value of their outstanding shares, consistently outperform large stocks in percentage gains in price.
Reinganum has found that in good times, the little stocks do extremely well. In bad times, though, they are hit harder than big stocks. For instance, a 10 percent drop in market prices overall, can produce a 15 percent decline in many OTC stock prices.
Though there is no foolproof method to pick winners, investors can increase their odds.
One way to go into little OTC stocks is to pick enough at ramdom to benefit from average performance. Reinganum found that with random portfolios of 10 small over-the-counter stocks, the net yearly result would be a sharp improvement in value of the 10-stock group as a whole.
But keep in mind that if a brokerage salesman is calling with tips on hot over-the-counter growth stocks, the undiscovered profit potential is gone if it ever was there. In addition, there is often manipulation of little issues that are sold by phone to mass markets of investors.
The OTC market is not for lazy investors. To do well, investors have to research these stocks.
Several newsletters specialize in weeding out jewels among the small stocks. One is the Value Line OTC Special Situation Service (711 3d Ave., New York, N.Y. 10017), which costs $300 a year.
To get a list of all 11,000 or so companies that trade over the counter, get a copy of the daily Pink Sheets from a stockbroker or buy one of several publications by the National Quotation Bureau (Plaza Three, The Harborside Financial Center, Jersey City, N.J. 07302), which publishes the Pink Sheets. The company issues a Weekly Price Digest for $22 a month and a twice-a-year National Stock Summary for $65 a copy.
A statistical sweep of 2,400 of the OTC companies is possible with a computer software system just introduced by the Unlisted Market Service (49 Glen Head Rd., Glen Head, N.Y. 11545).
The software service is available on-line through The Source, Quotron or Newsnet or can be obtained on floppy discs for $695, plus $25 a month for updates.
Once an investor has identified, say, 30 potential OTC winning stocks, he is ready to begin his research. Information on these companies is in the Unlisted Market Service data base. Some also is available in computer data services offered by Media General and Standard & Poor`s.
From these sources and the corporate directories, the investor should find the address and write to each company requesting an annual report, quarterly reports (along with 10-K reports, 10-Q reports and any prospectuses filed with the Securities and Exchange Commission) and copies of any news releases issued in the last year.
Now that the investor is ready to dive into the figures, there are some terms to know and general guidelines to follow. But perhaps the greatest tool is common sense.
Keep in mind two key indicators: The dominance of a particular company in a small industry and companies that are operating in fast-growing industries. Throughout the OTC market, there are single-line companies that dominate tiny and obscure areas of American industry. These companies have little or no domestic competition in their specialty.
Since such companies prefer not to wave red flags at the Justice Department, they are not apt to claim to have monopolies, but a careful reading of the ”competition” sections in their annual 10-K filings will guide you toward small companies that dominate obscure markets.
Equally important is to find companies that have a toehold in a growing industry. Use common sense to decide whether there is any potential for growth or whether there would be an onslaught of big corporate competitors.
Investors can often buy the shares from brokers who are market makers, but there is little incentive to do that in terms of commissions or executions.
