In this article, I’ll be giving you five tips on how to spot and avoid penny stock scams. They are:
- Lack of financial reporting
- Shells and lack of business operations
- CEO pay structures
- Overuse of press releases
- Broken promises
We’ll go through each of these in detail below. As an initial note – not all companies that do this are necessarily fraudulent or scams. But these traits above are the common traits of past penny stocks that have been implicated in fraud.
What is a Penny Stock Scam?
For this article, we’ll be focusing on penny stock scams where the company itself is a scam. This means that the current management and insiders are personally trying to enrich themselves via fraudulent or dubious means. All of this is done at the expense of shareholders.
Generally, management enriches themselves either by paying themselves exorbitant salaries and/or by selling their own shares in the company after manipulating it. These exorbitant salaries are generally funded by selling new shares to investors to raise cash in the company. This cash then goes right to management rather than being reinvested into the business.
This article won’t delve into penny stocks that are being manipulated by outside parties for their own benefit. This can be done completely without the knowledge of current management. But that’s an article for another day.
Now that you know how penny stocks can be scams, let’s get into their tell-tale traits!
How to Avoid Penny Stock Scams
Lack of financial reporting
Right away, a huge red flag of a potential penny stock scam is if management does not have proper financial reporting. This means they do not meet the alternative filing standard of OTC Markets nor do they don’t perform SEC reporting.
To expand on this, this can also mean that their financial reporting to OTC Markets to remain as Pink Current or Pink Limited is extremely poor.
Generally, the more dubious a penny stock is, the less they will disclose (if anything) in terms of hard financial data. If they do report any financial data, they may have financials such as income statements and balance sheets that are missing data, don’t make sense, or have errors in them.
As a final thought – the alternative reporting standard of OTC Markets is not very difficult to comply with. You don’t need auditors, internal controls, or to follow a strict SEC format. So it’s easy for companies to provide bad information. But it’s also very telling if a company cannot even make sufficient reports to OTC Markets!
All of the above should ring alarm bells if you come across it.
Shells and Lack of Business Operations
This one is fairly self explanatory, but many penny stock scams do not have real business operations. Another word OTC Markets uses for these companies are “Shells”.
This means the company is just an empty company without a physical location, product, operations, etc. Management is therefore able to do, effectively, nothing from a business/operational sense.
Remember, management in these cases are looking to do as little as possible.
Management of these companies sometimes, but not always, rely on hype rather than actual business results to affect their share price. Many of these companies stay as shells for years, or indefinitely, while management enriches themselves with salaries and selling their own shares to gullible investors.
Always be careful investing in shells and verify company operational facts whenever possible.
CEO Pay Structures
This is a fairly simple one, but always try to verify how management is compensating themselves. The CEO’s pay should ALWAYS be consistent with the level of value they bring to a company.
A CEO of a shell that doesn’t do anything should be getting paid $200,000 per year. Remember, you as the shareholder are paying the CEO! If you’re not comfortable with that, then you definitely shouldn’t invest.
Overuse of Press Releases
This was mentioned above, but scam penny stocks generally do not have real operational progress/results to build their share price from. They like to rely on hype instead.
This hyping almost always comes in the form of press releases with vague promises and high aspirations. Common examples include:
- Announcing acquisitions that are nowhere near complete.
- Stock buyback programs for companies without any cash on hand, nor profitability.
- Business direction pivots, generally moving from one buzzword industry like Blockchain to another like AI.
If you see a company doing absolutely nothing operationally quarter after quarter, but they issue press releases every week, the company may be very suspect.
Broken Promises
As a continuation to overuse of press releases, broken promises are an extremely common hallmark of scam penny stocks.
If a company constantly issues press releases, business plans, etc. that never come to fruition, that is a massive red flag.
Bottom Line
You should now know some common signs of penny stocks. Again, not every company that does this is a scam. However, common penny stock scams generally have one or more of these traits. Sometimes all of them bundled into one!
DISCLAIMER – THIS ARTICLE IS NOT FINANCIAL ADVICE. THIS ARTICLE DOES NOT CONSTITUTE A BUY, SELL, OR HOLD RECOMMENDATION ON ANY SECURITY MENTIONED HERE. THIS ARTICLE CONSTITUTES MY OPINION AND NOT A STATEMENT OF FACT. ALL INFORMATION REGARDING THE FINANCIAL SECURITIES MENTIONED IS ACCURATE AS OF JANUARY 24, 2024. DO YOUR OWN RESEARCH.