Most investors are weary about the Over the Counter Bulletin Board (OTCBB). That’s understandable, considering the amount of bankruptcies, shell companies and de-listings that occur in over-the-counter markets. But there is a very large misconception that is widely shared among investors: That no over-the-counter company has to report current financial information. That is the case with the Pink Sheets, but not so with the OTCBB.

You see, before 1990 the over-the-counter securities market was a Wild West show. Not complete lawlessness, but close to it. So that year, the Securities and Exchange Commission started the OTCBB as part of the Penny Stock Reform Act. The OTCBB’s main purpose was to bring more quotation and last-sale information. By 1999, the OTCBB had evolved to the point where every company had to report regular financial information. This sets it apart from others, specifically the Pink Sheets, which don’t have reporting requirements.

We’ve discussed the Pink Sheets extensively here at Penny Sleuth. There are absolutely no requirements for Pink Sheet companies. They don’t have to file regular and current financial information (although a recent classification system is slowly changing that), they don’t have a strict minimum market cap requirement, and they certainly don’t have to pay the couple hundred thousand dollars just to be traded on a major exchange.

The OTCBB, on the other hand, is a much stricter form of the Pink Sheets. OTCBB companies have to keep up with regular financial reporting. This truly makes all the difference in the world. Here’s an example:

Company A is traded through the Pink Sheets, and Company B is on the OTCBB. Both companies issue press releases claiming to be “transitioning their businesses.” Company A really just slumps into a shell company state, because no one has to know what’s actually going on over there, whereas Company B has to file regular quarterly earnings. If it doesn’t, the OTCBB will add a dunce cap (or in this case, the letter “E” to the end of the company’s ticker), which immediately tells investors that the company isn’t showing enough corporate responsibility. This can make or break that investment. People invested in Company A are out of luck. Company B investors can get out before the going gets too tough.

But, that doesn’t explain why OTC companies are even worth investing in. There are two reasons to get involved in the OTC market…

The main reason most OTCBB investors keep trading these securities is the profit potential. Obviously, a $300 billion Blue Chip can’t double in size too easily. That doesn’t give investors too much to work with. A $3 million company can double in size overnight without flinching. Which would you rather have in your portfolio?
The second reason is also a pretty clear one. Because many of these tiny companies are working on a much smaller scale, overall general market attitude has a very small effect on them. There are almost never any big institutional investors or large mutual fund managers pulling money in and out of these companies. These two groups of investors are more interested in macro market sentiments than what individual companies are doing. So, in bear markets, it’s quite possible to have a bunch of these OTCBB companies take off.

In a 2001 study published in the Journal of Alternative Investments, a four-year period of OTCBB trading was studied for a risk-to-return ratio. The interesting conclusion they came up with was that OTCBB stocks didn’t reflect what the general market was doing at that time. There were some years of extreme bullish overall sentiment, which can be defined as a solid return on the S&P, and the overall OTCBB market lost a lot of money. On the flip side of that, years of extreme bearishness in the S&P, along with the major exchanges, showed positive returns for many OTCBB companies.

So whether you are a safe-bet kind of investor or a fly-by-the-seat-of-your-pants type, there is still a place for you, just off the major exchanges.

Sincerely,
Jim Nelson
November 21, 2007

P.S.: Over the last three months, there was one OTC hybrid battery company that shot up over 200%. Greg “Gunner” Guenthner’s Bulletin Board Elite readers got to see a large chunk of those profits. For more information on a rare type of OTC company, aptly named “Jumpers”.

Jim Nelson

Jim Nelson began his investing career during the tech boom at age 14 – with purchases of Starbucks and AOL. Early inspiration came from an old Tweedy Brown whitepaper: “What Works in the Market.” He graduated with a degree in Political Science from Pittsburgh University, Nelson focuses on income investing, including dividends, covered calls, and fixed-income. Additionally, he covers MLPs, ADRs, utilities, consumer staples and tobacco. Nelson is the managing editor of Lifetime Income Report.

View articles by Jim Nelson