Looking Through Pink Sheets for Value Investments

by: Alex B. Gray

There is a world full of stocks that many investors are either unaware of or just not comfortable with due to the fact they do not trade on one of the major U.S. stock exchanges. That world is known as the Pink OTC Markets (Pink OTC). The Pink OTC is a service where many stocks that do not trade on the major exchanges can be found including many international stocks. This marketplace used to be known as simply the “Pink Sheets”, deriving its name from the color of the paper the quotes for these stocks were printed on several years ago and distributed by brokerage firms.

I am always looking for investments that are closer to their bottom than their top. Under certain circumstances, individual securities that trade only through the Pink OTC marketplace will give me this opportunity. This will be the first in a series of articles where I will discuss stocks that trade through the Pink OTC marketplace that I believe to be of investment quality. However, before I discuss any individual securities, I want to dedicate this article to explaining the Pink OTC marketplace and a few guidelines to consider before making a purchase.

The Pink OTC marketplace is essentially a quotation service that collects and publishes on its website quotes for Over-The-Counter securities. There are many reasons companies trade on the Pink OTC. One reason is to give their investors a market in which to trade their stock without taking on the laborious and expensive reporting requirements of the SEC. In fact, many of the companies were once traded on one of the major exchanges only to delist in order to save the cost and time of SEC reporting. (Many thanks to Sarbanes-Oxley law.)

Even though many of these companies do not report to the SEC, they do make their financial information available to potential investors either by request or via their website. In addition, several large foreign companies are listed on the Pink OTC because they desire a presence in the United States, but their financial statements are not prepared according to Generally Accepted Accounting Principals (GAAP). While GAAP does help to standardize reporting, it will not save you from making a poor investment. Anyone remember Enron, Worldcom, HealthSouth? I think you get the point.

Generally the nature of the companies that are listed only on the Pink OTC make researching such companies much more difficult, given that the key to research is the availability of information. Since the companies listed on the Pink OTC are not always required to report, financial statements and news may not be readily available. This presents a great opportunity as many investors do not want to put forth the extra effort and therefore, do not even look at these companies as potential investments.

While some of the companies listed on the Pink OTC have an active market for their securities, many of the securities of Pink OTC-listed companies are illiquid and trade infrequently. This is where you want to be very careful and understand what you are getting yourself into if you are inclined to invest. This is not a marketplace for a novice investor or an investor not willing to do their own research.

Below are a few tips for buying the securities of companies listed only on the Pink OTC:

  • Research, Research, Research. I cannot emphasize this enough. While you should always do plenty of research before buying any security, it is even more important when buying into companies that are not required to report.

  • Always use limit orders. A limit order is the price you set with your broker as the price you are willing to pay for a particular security or the price for which you are willing to sell.

  • Be very patient. Many of the stocks that are listed on the Pink OTC have very little liquidity. Therefore, the bid/ask spreads can be wide. Let the price come to you by using limit orders as discussed above.

  • Analyze your own financial situation. Very seldom are Pink OTC investments going to be short-term trades, but rather long-term investments. Make sure you will not need the cash you are about to invest for at least 2-3 years. As mentioned earlier in this article, many Pink OTC companies lack the liquidity that might be needed if you need to raise cash quickly. You may be forced to sell under your desired price if you are in a must sell situation. As with any investment in the stock market, make sure it is money you can afford to lose.

  • Do not get caught up in the story of a penny stock. Make sure the company has a long-term track record and a real business and not just a concept. While these concept stocks can move quickly to the upside and you might think “what if”, many move quicker to the downside and become worthless.

  • Be very wary if you see a company self-promoting and issuing too many press releases. Also, many of these companies will hire so-called analyst to promote their stock. Quality companies generally do not have to use these tactics to get the attention of the investment community.

  • Beware of the “pump and dump”. These are stocks, generally trading for just pennies per share, that get promoted aggressively and even bought early by the promoters to push the price up and then dumped by the promoters leaving late comers “holding the bag” as the price plummets. You will find these stocks being promoted primarily on message boards, blogs, unsolicited faxes, and through spam email. Please ignore these attempts to suck you in and do your own research. There are always exceptions, but most stocks that trade for pennies deserve to trade for pennies.

In recent years, the management of the Pink OTC has made serious efforts to improve both the reputation and the transparency of the securities listed on the Pink OTC. They have added several new market tiers within the Pink OTC from Pink Sheets Current Information to the buyer beware Caveat Emptor. They have also added a couple of additional listing markets that include the otcQX and otcQB. The otcQX is primarily an alternative U.S. market listing for foreign and domestic securities offering investors transparent trading and quality information. The otcQB is a market that will help you identify companies that are current with reporting requirements to the SEC or a U.S. banking or insurance regulator. Click here to visit the Pink OTC website to view a complete listing of the current market tiers and descriptions.

With the many improvements in the Pink OTC and the fact that many quality companies have made the decision to delist, it may be a great place for experienced investors to begin looking for values. One company in particular that might be worth a look is Pink OTC Markets, Inc (OTC:PINK). This is the company that provides the listing platform for the Pink OTC. The company has a clean balance sheet, increasing year over year revenue and has been profitable for the last 3 years. This is not necessarily the typical value play I look for on the Pink OTC, but it is looking like it could be a great growth story. It is worth noting that the company announced on August 6, 2010 that it will restate certain financial statements dating back as far as 2006 due to $1.3 million in accounts receivable from the company’s Market Data Licensing line of business that may be uncollectible primarily due to errors in collection procedures for market data sales reported by third-party vendors during the period from 2003 through 2008.

The Pink OTC is also a great place to find foreign stocks that trade in the U.S., but not on any of the major exchanges. You might recognize companies such as Daimler A.G. (OTCPK:DDAIF), Volkswagon A.G. (OTCPK:VLKAY), Nestle S.A. (OTCPK:NSRGY), Roche Holdings Ltd. (OTCQX:RHHBY), and Bayer A.G. (OTCPK:BAYRY), just to name a few.

I will be making you familiar with other Pink OTC traded stocks, both foreign and domestic, in my upcoming series of articles focused on this marketplace.

Disclosure: No positions at the time of this writing.