Saturday 30 April 2011

Two Rules For Trading Pink Sheet Stocks

 

Tony Sagami

I have been touting Asian stocks for years not because I was born in Japan but because that is where the best stock market opportunities are to be found.

There are three ways to invest in foreign stocks:

Option #1: Buy American Depositary Receipts, or ADRs. ADRs represent ownership in the shares of a non-U.S. company that trades in the United States. ADRs enable U.S. investors to buy shares in foreign companies without the inconveniences of cross-border and cross-currency transactions.

They carry prices in U.S. dollars, pay dividends in U.S. dollars, and can be traded like the shares of U.S.-based companies. Many Asian companies, including Toyota, Honda, China Mobile and Sony — trade on the New York Stock Exchange through ADRs.

China, India and Japan offer the most of all the Asian countries.

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Option #2: Buy on the Home Exchange. There are hundreds of Asian ADRs traded on the NYSE and Nasdaq, but that is just the tip of the Asian iceberg. There are TENS OF THOUSANDS of other Asian stocks traded on their home exchanges in Tokyo, Hong Kong, Singapore, Seoul, Jakarta, and other major Asian cities.

While ‘most’ Asian countries welcome your investment business, there are exceptions:

CLOSED DOOR: Taiwan and mainland China allow only large institutional investors. U.S. investors are not allowed to invest directly into the Taiwan Stock Exchange.

RESTRICTED LIQUIDITY: Vietnam requires that you leave your money in the country for at least a year. I don’t know about you, but I will not invest in anything that restricts my liquidity.

NO RESTRICTIONS AND SIMPLE: Hong Kong, Singapore, South Korea, Japan, Indonesia, Malaysia, and Thailand.

NO RESTRICTIONS BUT NOT-SO-SIMPLE: India, Cambodia, Pakistan and the Philippines.

I don’t know why, but most investors I talk to seem to have a phobia about buying stocks on a non-U.S. exchange. They mistakenly think that investing in foreign stocks is difficult and expensive.

It costs a couple more dollars to trade foreign stocks but no more than $20 or $30 per trade if you use the right broker. Bottom line: Buying foreign stocks is simple, easy, and inexpensive.

Option #3: Buy on the U.S. Over-The-Counter Market. The over-the-counter market is also known as the “Pink Sheets” market. The Pink Sheets are a daily publication compiled by the National Quotation Bureau with bid and ask prices of over-the-counter stocks.

Unlike companies on a stock exchange, companies quoted on the Pink Sheets system do not need to meet minimum requirements or file with the Securities and Exchange Commission (SEC). The name “Pink Sheets” comes from the paper color that quotes were historically printed on.

The Pink Sheets have a horrible reputation. Whenever you hear about a stock getting de-listed from the NYSE or Nasdaq, it ends up on Pink Sheets, a marketplace primarily filled with penny stocks and borderline insolvent companies.

However, there is a wide range in the quality of issuers whose securities are traded on the Pink Sheets — from major international conglomerates to very small, highly speculative, often worthless companies.

The Pink Sheets: Hide and Seeking the World’s Best Foreign Stocks

There are roughly 15,000 stocks traded on the Pink Sheets, and most of them are worthless.

But there is one sub-category of Pink Sheet stocks that is worth your time and is the source of some of the very best values.

Any stock that trades on the Pink Sheets falls into one of these two categories: (1) companies that don’t meet the listing requirements of the New York, American or Nasdaq stock exchanges or (2) companies — usually foreign — that are unwilling to jump through the regulatory, legal, and accounting filings that accompany listing on the major exchanges.

The second category is foreign companies. For example, everybody has heard of Nintendo, and it is certainly not some crappy penny stock.

The only reason Nintendo is on the Pink Sheets is that it — like many foreign companies such as Volkswagen and Nestle — sees no reason to create a duplicitous legal and accounting department just to be traded on the NYSE.

These huge international companies already meet the filing and regulatory requirements of their home countries, but they would have to open and maintain an English-speaking version of those same offices.

A double legal team, double accounting team, as well as staff that are experts at U.S. securities regulations requires a huge financial and time obligation that a lot of foreign companies are unwilling to undertake.

Plus, these foreign companies have already met all those legal, regulatory, and accounting requirements in their own country and feel that the burden is on YOU to read/translate their home country filings.

Clearly, companies such as Nintendo, Volkswagen or Nestle are not borderline insolvent pieces of financial junk. They are thriving, profitable, household-name companies that are every bit as reputable as any U.S. blue chip company.

The biggest problem for most of the 15,000 stocks that trade on the Pink Sheets is that the U.S. companies on the Pink Sheets are indeed borderline insolvent pieces of financial junk. The foreign companies, however, can be hidden gold mines.

Here are my two rules for investing in Pink Sheet stocks.

Rule #1: Stick to non-U.S. companies.

Rule #2: Always use limit orders when buying/selling. Many stocks, both foreign and domestic, suffer from a lack of trading volume. Many of the Pink Sheet stocks don’t trade for days or even weeks at a time and suffer from Grand Canyon-sized bid/ask spreads. It is pretty hard to make money on a stock when the market maker is killing you for a 10% to 25% bid/ask spread on both sides of the trade.

Market Order: A market order does not have a set price and is therefore executed immediately at the current ‘market’ price. Markets, especially OTC markets, can be highly volatile, and the price of execution may differ dramatically from the price at time of order entry. Those who use market orders are more concerned about the speed of the execution as opposed to the price.

Limit Order: A limit order has a set price and may only be executed at the set price; however, a limit order may never get executed because the market may move away from the set price. Those who use limit orders risk not having an order executed.

As long as you follow those two rules, the Pink Sheets is an underappreciated market filled with some of the best bargains you will ever find.

Best wishes,

Tony

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