Penny Stocks and the Need for Buyers to Beware

[riskreturn]

The pace at which prices of penny stocks (and a number of non-penny stocks) have been skyrocketing seems to be a cause for alarm. Below are P/E ratios (as at market price on 25 February, copied from FSDH Securities daily stock updates):

AGRICULTURE
Afprint Nig. Ltd - 349.57
Ellah Lakes - 399.11
Livestock Feeds - 451.47


AIRLINE SERVICES
Nigerian Aviation Handling Co (NAHCO) - 555.78

AUTOMOBILE & TYRE
Intra Motors - 194.30

BANKING
Unity Bank - 105.96

CHEMICAL & PAINTS
African Paints - 130.00

COMPUTER & OFFICE EQUIPMENTS
Thomas Wyatt - 1,318.68

FOOD/BEVERAGES & TOBACCO
UTC - 159.97

HEALTH CARE
Ekocorp - 101.71
Evans Medical - 1,151.53
Morison Industries - 169.05
Neimeth International Pharm. - 112.53
Pharma-Deko -224.02

HOUSEHOLD/INDUSTRIAL APPLIANCES
Vono Products 18,380.6

INSURANCE
Continental Reinsurance - 128.52
Cornerstone Insurance - 101.60
Equity Assurance - 2,655.30
NEM Insurance - 5,025.70

PACKAGING
Poly Products 456.87

PETROLEUM MARKETING
African Petroleum - 102.43
Eterna Oil & Gas - 351.43

SECOND-TIER SECURITIES
Adswitch - 184.63
Juli - 567.41

In addition to the above, there are many that have not been making profits (so that P/E ratios are not applicable to them) but which have increased in price several folds in less than a year. Also, there are many more with P/E ratios, though not above 3 digits (i.e., 100) but which are trading at uncomfortably high P/E ratios. Let us, as a rule of thumb, adopt 20 as threshold of comfort P/E ratio for companies that have not just have shares diluted through POs and are not just recovering from loss-making situation(which would not be too conservative, given historical situation as welll as current situation with banking stocks that have not been diluted through recent POs). In that case, we would find that not less than 80% of penny stocks are trading at P/E ratios above this threshold of comfort.

The above note is because I strongly feel that participants in this forum should take care so as not to be a victim of this pro-penny stock sentiments, as indiscriminate purchase of such stocks can result into heavy looses. Instead, they should examine the fundamentals of each such stock on a case-by-case basis and make sure that the fundamentals justify the price.

Unfortunately, SEC's recent Caveat Emptor warning covered only indicriminate subcription to PP, without also referring to indiscriminate purchase of stocks (particularly, penny stocks) without making sure that the fundamentals justify the prices. I can recall in 2004 when Nigerian Breweries was trading at an outrageous price (it got to 81 Naira per share, after adjusting for a 1 for 1 bonus) and the Director-General of NSE was still vouching that the price would likely double in a near term (as she was promoting her own office the way she understood - which was a disservice to the victim investors). The CEO of SEC (now CBN-appointed CEO of Spring Bank PLC) immediately countered her remarks by seriously warning investors against purchasing NB shares at such an outrageous price. Since that time, the highest that the CBN share has attained is around 54 Naira. The relevance of this story is that the present CEO of SEC too should try to emulate his predecessor by cautioning investors against specific stocks that are trading at outragously high prices. It does not augur well for capital market development if many investors (even if due to ignorance and lack of sophistication) should get their fingers burnt in the rather inevitable crash of penny stok prices.

[pumping]

Good analysis and thanks for watching the back of fellow investors.

I know it will be hard for investors to heed your warnings because these stocks have been "delivering". I just hope some will take caution because when the bears arrive, alarm go blow.

[hispy99]

Originally Posted by riskreturn

The pace at which prices of penny stocks (and a number of non-penny stocks) have been skyrocketing seems to be a cause for alarm. Below are P/E ratios (as at market price on 25 February, copied from FSDH Securities daily stock updates):

AGRICULTURE
Afprint Nig. Ltd - 349.57
Ellah Lakes - 399.11
Livestock Feeds - 451.47


AIRLINE SERVICES
Nigerian Aviation Handling Co (NAHCO) - 555.78

AUTOMOBILE & TYRE
Intra Motors - 194.30

BANKING
Unity Bank - 105.96

CHEMICAL & PAINTS
African Paints - 130.00

COMPUTER & OFFICE EQUIPMENTS
Thomas Wyatt - 1,318.68

FOOD/BEVERAGES & TOBACCO
UTC - 159.97

HEALTH CARE
Ekocorp - 101.71
Evans Medical - 1,151.53
Morison Industries - 169.05
Neimeth International Pharm. - 112.53
Pharma-Deko -224.02

HOUSEHOLD/INDUSTRIAL APPLIANCES
Vono Products 18,380.6

INSURANCE
Continental Reinsurance - 128.52
Cornerstone Insurance - 101.60
Equity Assurance - 2,655.30
NEM Insurance - 5,025.70

PACKAGING
Poly Products 456.87

PETROLEUM MARKETING
African Petroleum - 102.43
Eterna Oil & Gas - 351.43

SECOND-TIER SECURITIES
Adswitch - 184.63
Juli - 567.41

In addition to the above, there are many that have not been making profits (so that P/E ratios are not applicable to them) but which have increased in price several folds in less than a year. Also, there are many more with P/E ratios, though not above 3 digits (i.e., 100) but which are trading at uncomfortably high P/E ratios. Let us, as a rule of thumb, adopt 20 as threshold of comfort P/E ratio for companies that have not just have shares diluted through POs and are not just recovering from loss-making situation(which would not be too conservative, given historical situation as welll as current situation with banking stocks that have not been diluted through recent POs). In that case, we would find that not less than 80% of penny stocks are trading at P/E ratios above this threshold of comfort.

The above note is because I strongly feel that participants in this forum should take care so as not to be a victim of this pro-penny stock sentiments, as indiscriminate purchase of such stocks can result into heavy looses. Instead, they should examine the fundamentals of each such stock on a case-by-case basis and make sure that the fundamentals justify the price.

Unfortunately, SEC's recent Caveat Emptor warning covered only indicriminate subcription to PP, without also referring to indiscriminate purchase of stocks (particularly, penny stocks) without making sure that the fundamentals justify the prices. I can recall in 2004 when Nigerian Breweries was trading at an outrageous price (it got to 81 Naira per share, after adjusting for a 1 for 1 bonus) and the Director-General of NSE was still vouching that the price would likely double in a near term (as she was promoting her own office the way she understood - which was a disservice to the victim investors). The CEO of SEC (now CBN-appointed CEO of Spring Bank PLC) immediately countered her remarks by seriously warning investors against purchasing NB shares at such an outrageous price. Since that time, the highest that the CBN share has attained is around 54 Naira. The relevance of this story is that the present CEO of SEC too should try to emulate his predecessor by cautioning investors against specific stocks that are trading at outragously high prices. It does not augur well for capital market development if many investors (even if due to ignorance and lack of sophistication) should get their fingers burnt in the rather inevitable crash of penny stok prices.

I agree with you that NSE officials act irresponsibly when it comes to making statements on the direction of the market. NSE officials have no business promoting a stock or stating as a matter of fact that the market is "going up". I posted a comment by Musa Elakama (Assistant DG at NSE) a while back where he said that the previous bullish runs in the market would be a child’s play compared with what would happen soon. He based this statement on the fact that the highest priced stock on the stock exchange was still less than one British pound!

However, I do not agree that it is the job of the NSE or SEC to warn investors not to buy certain stocks based on fundamentals; that is the investors' responsibility. The SEC can organize/promote/sponsor workshops/seminar to educate investors, but making outright comments on buy/sell decisions should be the job of the investor. The SEC should focus on market regulation, levelling the playing field e.t.c Just becase a stock is trading as a PE of 200 today, does not necesarily mean it's a bad buy (I wont most likely buy the stock, except i get inside info), but it's possible that investors have identified "exponential growth" in such a company and are willing to pay that premium now. The SEC/NSE do not research companies so they may not be aware of the "exponential growth" that a diligent investor has identified in a particular firm. I do not remember the U.S SEC or the NYSE making such "do not buy this stock" statements during the tech bubble in the U.S and believe me, there were very outrageous and fantabulous PE multiples then.

Thanks for posting this outrageous PE multiples though, it helps to put things in further perspective. Everyone should shine their eyes, make gnashing of teeth no materialize o.

[cfa]

I actually think the SEC should know better and not allow some of these stocks to be listed based on their respective floats (percentage of total shares allowed to be traded) and their trading volumes.

When you have a situation where avg volume for a stock is less than 10,000 the stock will not be trading in a free market place and very much subject to manipulation. Of course that is what's happening to some of these stocks.

Some of these stocks have also not filed financial statements in years. That is also mind boggling. Those companies should also not be trading on the exchange.

I think they are gradually feeling the heat and that's why they made the announcement of the 5 stocks that were alleged to be manipulated.

I expect the way down for these stocks to be quite spectacular, keep in mind that when the stuff hits the fan getting out of these stocks will probably take days and weeks becasue of the insignificant volume traded per day.

Anyway, this needs to change, it is a big minus as opposed to a plus to our capital markets.