Anyone who has traded the markets for more than a few years understands that much of a stock's price has nothing to do with fundamentals and everything to do with manipulation, hype, fraud, and deceit -- perception drives short term stock prices, while value ultimately decides where a stock belongs in the long run.
Many traders prefer to use options to play pump and dump type stocks as selling calls provides a bit of a cushion, and often traders benefit from large call premiums of 10% or so per month. Paid pumps, dirty market makers, fluff news articles, and email spammers can move a stock from $1 to $15 in less then a week at times, as stocks essentially are a supply and demand game, and with no real assets a worthless company can many times fetch a $500MM valuation on the exchange.
So many times, legitimately promoted stocks blow up and lose everything for investors. One example was Energy Conversion Devices (ENER), which dropped from $85 to $3.85... Shares of Sulphco, KFX Energy, and countless other questionably fraudulent companies have gone from half a billion dollar valuations to becoming nothing more then a public shell trading for pennies per share or in Chapter 11.
Shorting is much harder than making 20% buying and holding an index fund, but uncovering frauds and profiting from them is a better strategy in many ways, as price eventually finds value when an Enron or other fraud is uncovered by some honest intern at a Big 5 accounting firm, or a sleuth analyst who spends thousands of hours ripping through financial statements on the weekends and after the close of trading.
Some red flag areas that alert short sellers are restated financial statements, SEC probes, high insider selling, little to zero net income, channel stuffing, aggressive revenue and income recognition, rising inventories or accounts payable, corporate headquarters that are overly lavish, arrest records, prior SEC violations (usually looking for fraud offenses), paid stock promoters disclosing their compensation to blatantly pump a stock, a 1,000% increase in a stock over a short period of time, stocks that are recommended to you in a spam email, etc...
Most penny stock pump and dumps are of the spam variety, however many larger cap stocks have been pumped by paid promoters in the past such as Quepasa Corp. (QPSA.OB) , Hyperdynamics (HDY), etc... OpenTable (OPEN) seems to have an unusually large amount of fluff articles published in the news with high insider selling and a stock that has more than tripled in the recent past.
Here are some interesting short sale candidates and why I am looking to short them. Although I do not know if these companies are paid pumps/IE overvalued and overhyped; I do believe each of the following stocks could be interesting short candidates at some point in the future.
Royale Energy (ROYL) has spiked from $2 to $7.4 per share in the past month. The company has some interesting shale assets and recently signed a deal to sell one of its California properties. The company is heavy in Natural Gas, however has immaterial on balance sheet assets or net income and cash flow.
Hyperdynamics (HDY) has an $800MM valuation while its $50 plus million mainly came from a $35 plus million of share issuance. HDY owns a huge amount of leased acres in Guinea and the African government in that country is behind the name. HDY recently engaged a broker to help it drill wells, but I view this company as speculative play at a valuation north of $400MM unless it actually earns revenues.
Opentable.com (OPEN) at 156X earnings is a risky bet. Analysts have gone on television time and time again to promote the name, and Forbes has written several fluff pieces on the stock as well as many other finance publications, which begs the question-- why is OPEN trading for 10X the valuation metrics that Intel (INTC) receives in the market?
Salesforce.com (CRM) looks weak from a TA perspective after failing to break above the $150 level for the third time. Investors have not been able to drive the stock higher, even after hundreds of pumps from the likes of Jim Cramer and countless others that are admittedly "drinking the Koolaid" of the cloud revolution. Unfortunately, this revolution has not helped profits grow at the same rate as sales, and anytime you see a price to sales ratio of over 10X investors should wonder if something irrational is happening.
Demand Media (DMD) filed its recent 10K report and showed a loss of $38MM for the full year 2010 while the company commands a $330MM market cap. Recently Google (GOOG) changed the way it runs its article SEOs to feature more original, high quality work as opposed to content farms like DMD which write articles based on the highest Google searched words over a given day -- essentially ambulance chasing mixed with sweat shop waged bloggers.
So there you have it, 5 stocks to watch and to be very careful shorting if you so choose to trade these names. If you do choose to bet on eventual collapse, make sure to be nimble and to wait until the pump is over and the dump has begun.
Disclosure: I am short HDY, ROYL, OPEN, CRM, DMD.