I spend a lot of time researching tiny, over-the-counter companies. Many of which are too small to mention here. After crunching the numbers, reading the reports, and listening to the calls, I sometimes check out the message boards. If for no other reason than to have a chuckle. People on those things crack me up.

Anyways, on almost every single one, there is a string of comments about the company jumping to a major exchange. Message boarders love the idea that their tiny stock will be flooded with institutional money the minute it hits a major exchange. That makes perfect sense. But what they don’t realize is only 2% of OTC companies ever graduate to a major exchange. So, the odds of your company doing it are slim.

Sometimes, the message boarders are right. Their stock may graduate to the NASDAQ, and then they might see huge gains. It does happen. However, not all jumpers are like that. In fact, many do something quite a bit different from what most believe…

Falling Down After the Jump

In Dan Haltzclaw’s The Little Black Book of Microcap Investing, he studies this very subject. His findings are actually pretty shocking. According to Haltzclaw, over 90% of all recent jumpers see their share prices fall by an average of 33% in the first one to four months.

That’s not what the message boarders think. They honestly believe that the minute their stock jumps, all their problems will be over. Haltzclaw’s findings disprove that notion pretty handedly.

Here is a quick chart of one of these average jumpers:

But, that’s not the end of the story. In fact, it’s really the beginning of a much larger story…

Second Stage of a Jumper

It’s not that institutional money doesn’t ever come to these companies. Of course it does. Just not right away, as the message boarders seem to think. Why? Well, there are a lot of people that want to dump their shares too. Chances are, in the time between the graduation announcement and the jump, investors (most likely message boarders) are buying up a lot of new shares. When this happens, it gets other shareholders nervous. They see that they are sitting on nice gains, and want out. So, the stock gets listed, and early investors bail.

This usually starts a free fall for a few months until it levels back out. When that happens, we have a buying opportunity.

In his book, Holtzclaw found that six months after graduation, investors bring the share price back up to the graduation price. So, if you have a company that falls 50% after it jumps, and you buy it, chances are it will go up 100% to where it was trading at before. Brilliant! But, it’s not as easy as that…

Some stocks don’t follow this trend at all. Some just continue to go down, while others go up much more than just to the graduation price. Finding the right ones is not easy. It takes time and effort.

But it’s worth it. Investors of Transmeridian, after it initially slumped, go to realize gains of 333%!

We’ll keep looking for the next Transmeridian. When we find it, we’ll let you know…

Sincerely,

Jim Nelson
May 9, 2008

P.S.: Greg Guenthner and I spend a considerable amount of time diligently studying everything — management, balance sheets, growth rates, cash flow, etc… By doing this, we’re the first to find the right time to buy these second stage jumpers.

Editor’s Note: As always, send any questions or comments to us at jim@pennysleuth.com.

Profit from Graduation to a Major Exchange was originally featured in the Penny Sleuth.