Pump & Dump
I receive almost daily emails from
self-styled stock research firms alerting me to opportunities to get in
on the ground floor of exciting new businesses. These might be companies
that are close to developing cures for cancer and/or HIV, have recently
discovered rich gold deposits in Nevada, have developed a transmission
system that increases Internet speeds by a factor of 10—I think you get
While these stories are intriguing, alas,
many of these firms are more interested in making money from selling
stock to unsophisticated investors than they are about starting
groundbreaking new businesses.
Many of them start when their promoters
acquire a defunct “shell corporation,” that is a corporation with
publicly traded stock, but with no significant business. They typically
pump up the stock price via an intensive email campaign and then dump
their holdings when the share price is peaking. Hence, the name, “pump
Fortunately, you can easily spot pump and
dump stocks as well as other bad ideas. Here are six quick checks that
you should apply to every stock that you’re considering. It won’t take
long because you’ll disqualify a stock as soon as if fails any one of
these checks. The needed information is readily available on many
financial websites. I’ll use
demonstrate the process.
#1: Current Stock Price
You can avoid many bad ideas by simply checking the recent stock price.
Do that by getting a
quote on Yahoo’s main finance page (finance.yahoo.com).
Most worthwhile stock candidates trade well above $5 per share. If
you’re a conservative or risk-averse investor, rule out stocks trading
below that level.
However, some viable candidates do sink
below that level and then recover and go on to do great things. If
you’re okay with taking on some risk, it’s okay to consider cheaper
stocks, but be cautious about any stock trading below $1 per share, and
avoid all stocks changing hands below $0.50.
#2: Recent Prices
Stocks that have been heavily promoted via email often move from below
$0.50 per share to $1.00 or more during the campaign. Use Yahoo’s
Historical Prices report to check a stock’s recent trading history.
Rule out stocks that have mostly traded below 50 cents per share.
#3: Annual Revenues
Income Statement (Financials section). Yahoo displays the last three
fiscal year’s numbers. The top line of each column shows the total
revenues (sales) for the year. Most public corporations crank out sales
in excess $50 million annually, which would, since Yahoo lists the
figures in thousands of dollars, be displayed as 50,000.
Risk-averse investor should disqualify
companies with less than $50 million in sales. Otherwise, use $10
million as your minimum.
#4: Quarterly Revenues
For more recent data, select the
Quarterly Data option, which shows the last four quarter’s sales
figures in the same format that was used for annual sales.
All corporations doing any kind of business
at all should be racking up sales of at least $5 million per quarter.
Disqualify any company that doesn’t meet that requirement for the most
recent quarter. Risk-averse investors should require at least $10
Next check the company’s solvency by selecting
Balance Sheet (Financials section) and then
Data. Use the most recent quarterly data.
The balance sheet shows assets (what a firm
owns) and liabilities (what it owes). If liabilities exceed assets, the
company has a problem. Current assets and current liabilities are the
best way to measure a firm’s financial strength. Disqualify any
companies whose current liabilities exceed current assets.
#6: Change of Business
While still on Yahoo, select
SEC Filings (Company section) and pick the most recent Quarterly
(10-Q) or Annual (10-K) report. Click on the Summary link and read the
Overview section. This will only take you a couple of minutes.
Disqualify any company that has recently completely changed its business
plan (e.g. from mining to high-tech), typically as part of a merger.
Doing these six quick checks will eliminate
most stocks that don’t have real businesses. But passing these tests
simply means that you’re dealing with a real company, not that you’ll
make money owning its shares.