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.

A few weeks ago, I met up with my colleague Chris Mayer just outside of Washington, D.C., to grab a bite and commiserate on the state of the markets. Chris, a much-heralded value investor, is the editor of Capital & Crisis and the author of the recent bestseller Invest Like a Dealmaker: Secrets From a Former Banking Insider.

We talked for quite a while about interesting companies we’ve come across in our research, and the industries we like and hate. And as we prepared to go our separate ways, one theme became quite clear: This is the most difficult market either of us has seen in a long, long time.

Nevertheless, a good company is a good company. And I think readers of my exclusive Bulletin Board Elite have plenty in their portfolios right now. Of course, if something changed our opinion on a particular stock, we would quickly get rid of it. But despite the recent swings in some of our positions, all of the reasons we bought in the first place are true.

It’s difficult to argue with unemotional logic. So while traders buy, sell and then buy some more as over-the-counter securities swing wildly up and down, we remain vigilant. This year holds many uncertainties for the market as a whole. However, almost every single week, the companies we follow inch closer and closer to discovery, approval and commercialization.

Yes, despite this rough and tumble market, we’re finally starting to see some of that progress come into play in share prices. Last week, my Bulletin Board Elite readers locked in somewhere between 45%-56% gains on one such company in just one day — and it’s one that I’m predicting will continue its upward drive as the word gets out on this power play.

The Power of Good Publicity…

Getting that word out is unquestionably valuable, but it’s not always easy to do. Stock in a great business is worthless until enough investors agree that there’s value to be found. And for the microcaps we deal with, it can be a bit frustrating at times that the average investor doesn’t see what we see…

That’s why investor relations can be so important to bulletin board companies. No, we’re not talking about some bogus firm running a pump-and-dump scam. Rather, this is an exercise in simply letting people know about undervalued buys so a company’s stock price can align with its potential…

We’ve seen more and more companies get that message recently — like in yet another of my Bulletin Board Elite picks, for example — and it’s a message that’s going to have a huge effect on a lots of readers’ portfolios…

Best,

Greg Guenthner
March 31, 2008

How the OTC Market Handles Rough Patches was originally featured in the Penny Sleuth.