Saturday, May 26, 2012

The Dow Jones Industrial Average Vs. Penny Stocks...

Nate over at Oddball Stocks has come up with a hell of a post as usual. He had apparently gotten a ton of questions about the safety of penny stocks in terms of de-listment or value recognition. Since he is a fan of the Walker's books (which, I also really like), he decided to do some research that through his own admission is un-scientific. Here is what I found fascinating:

Penny stocks from 1999 (13 years)
Out of 167 listed companies 63 are still listed.62.2% of the penny stocks had some sort of value realization event either positive or negative.
The results are interesting, it would seem that an investor who wants an external event to realize value would be better served buying exchange traded stocks and avoiding unlisted and pink sheet stocks altogether.
So what are some of the ways value was realized for these companies?  I didn't follow up on all of the companies that I had marked as no longer trading, it would have taken too much time.  I did follow up on some, of the 194 I probably followed up on 30-40 companies.  Most of the time I found their fate through a simple Google search.  Here are some of the terms I jotted down in relation to their final fate: liquidated, bought out, went private, bankrupt, purchased by parent.

When comparing this directly to the Dow Jones Industrial Average components of 1999 it doesn't seem that results are going to be that much (if any) better. For example, the average today stands at $12,454.83 which is roughly 16.35% higher than it stood the when the components were adjusted in November of 1999 (it's price level was $10,704.48) Several of the companies were acquired (SBC Communications), changed their name (Allied Signal took on Honeywell's name, but, is no longer a component), or spun off (Philip Morris International coming from Altria, which if still together, probably would be a component).

Several of the 1999 components have been HUGE investment disasters: General Motors, Citi, and Eastman Kodak come to mind. Others, such as Dupont or Coca-Cola moved little so as to kind of averaged things out. Whereas a few, such as Exxon Mobile, did extraordinarily well, being balanced out by the near 50% pounding taken by International Paper. Some of the components that are currently listed, such as Hewlett-Packard probably stand a good chance of being kicked out at some point in the near future. Then, there are the companies aren't even included in the Dow, just because of how the index calculates it's pricing... the idea that there isn't some way for Apple and Berkshire Hathaway to be included in the index that is meant to more or less mirror the health of the US economy is patently absurd. It seems to me that all one would have to do is divide both the price and the momentary changes in price of Berkshire Hathaway by say, 20,000 to get it to a price that would be similar to most other DJIA companies before plugging the stock into the calculation formula. It seems to me that this would be child's play given what needs to be done to the divisor over time.

Getting back on track...

What's to be gathered from this very unscientific look at the DJIA? Just because a company is one of the index's components doesn't mean that it is a safe, good, or even bad investment. Are penny stocks or dark companies inherently less risky that DJIA component companies? Not necessarily- a lot of pink sheet companies are fly by nights, ripe for manipulation, and outright frauds. However, if you pick through enough of them, there are some real gems out there and I would rather be an owner of those companies than virtually anything that is on the Dow... such as Western Lime that Nate mentioned in his writeup.

Disclosure/Disclaimer: I have no financial position in any regard to any of the entities mentioned. I do use a lot of the products and services that they produce and offer. I often invest in small and illiquid companies that are often referred to as "penny stocks". I reserve the right to change any of our positions at any time. This is not advice of any kind and is solely my own opinion. Always do a ton of your own research in regard to anything that I say, do, write, or so much as even think about.

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