Making BIG Money in Small Stocks Beat the Street with Stocks under $5 by Bill Mathews Preface iii Library of Congress Cataloging Making Big Money in Small Stocks / Bill Mathews ISBN 0-9745875-0-8 ©2004 by Mathews & Associates, Inc., Hoffman Estates, IL All Rights reserved. No part of this book may be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or by any information storage and retrieval system, without permission in writing from the publisher, except for the inclusion of brief quotations in a review. This book is designed to provide information on investment strategies. It is sold with the understanding that the publisher and author are not engaged in rendering legal, accounting or other professional services. If legal or other expert assistance is required, the services of a competent professional should be sought. Every effort has been made to make this book as complete and as accurate as possible. However, there may be mistakes, both typographical and in content. Therefore, this text should be used only as a general guide and not as the ultimate source of investing information. The purpose of this book is to educate and entertain. The author and Mathews & Associates shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to have been caused, directly or indirectly, by the information contained in this book. Preface My primary reason for writing Making BIG Money in Small Stocks is to help you become the best investor you can be. Statistics indicate that 70 percent of all investors lose money in the stock market. Why? Most investors buy poor quality stocks at too high a price. They either get greedy and don’t take their profit, or ignore signals that indicate the price may go down. Then they end up selling their stocks for a loss. This book will give you a better understanding of the stock market in general, and how to pick quality stocks, buy them at a good low price and sell for a tidy profit. My investing philosophy has worked both in good markets and bad. Basically, I look for a company that’s fundamentally solid, with increasing sales and earnings that is selling near its 52-week low price. In its simplest form, it’s finding the bargain. I’ve used that philosophy successfully for over 25 years, and call it the “CHEAP” philosophy. Almost everyone has heard the old adage, “Buy low and sell high”. Logically, that is the only way an investor will make money. The problem most investors have is they don’t think for themselves. Instead, they follow the herd. They get caught up in momentum buying, where they buy a stock that has hit new highs on the assumption that it will keep going higher. While momentum buying works well during bull markets, investors who followed that strategy after March 2000 through 2002, lost gigantic sums of money. Investors now realize that investment strategies, like momentum investment, which worked in the bull market of the 90s, may not make the grade in today’s more uncertain market. Political upheaval, terrorism, and accounting irregularities in the billions of dollars have caused an edgy market to become ever more volatile. Where should the investor turn? Back to the basics. Looking back over 25 years of various investment strategies touted by different experts, the one strategy that I’ve seen work in both good markets and bad is buying low and selling high. J. Paul Getty stated it best in his well-known book, How to be Rich. He wrote that an investor should “Buy when everyone else is selling and sell when everyone is buying. This is more than a catchy slogan. It is the very essence of successful investing and accumulating wealth.” Quality, low priced stocks are very attractive to the small investor because they have the potential for huge profits. However, it is vital that Preface v you invest in a company that has solid fundamentals AND purchase the stock at the right price. Would you purchase an automobile for $45,000 that was selling for $30,000 just last week? No, you wouldn’t because it’s too expensive! It’s common sense, but too many investors get caught up in the excitement of investing and jump on the bandwagon to purchase a great little stock, which just doubled in price. Sound familiar? We hear it all the time. Doesn’t it make more sense to get into that stock before it skyrockets? That’s what you’ll learn to do if you follow the techniques in the book. Recently I watched some experts on CNBC issue buy recommendations on stocks they believed were good investments. One expert liked CarMax at $39. CarMax (KMX) is a great stock, but I liked it a lot better when I recommended it in my newsletter at $1.56. As usual, Wall Street finally discovered a stock after my subscribers had already made a 2,400 percent profit! Another expert liked Bradley Pharmaceuticals (BDY) at $31.50. I recommended that one at $1.03. My subscribers had almost a 3,000 percent profit by the time Wall Street liked the stock. Not only buying a quality stock, but also waiting for that stock price to drop to an attractive level is what makes my investment strategy so successful. You have to be in the right stock AT THE RIGHT PRICE to routinely make good profits on your investments. Of course it’s important to analyze the company before buying its stock. It used to be a time-consuming, tedious job to write or call a company for information to help you determine if the stock had investment potential. That changed with the advent of the Internet. With the click of a button, the Internet allows investors access to the current price and background information on almost any company. Where previously, analysts were the only ones who had such data at their fingertips, the Internet has become the great equalizer. The sudden availability of huge amounts of information has given everyone the chance to be a stock guru. However, the Internet is a two-edged sword. While it is easier than ever before to learn about a potential investment, it has also caused information overload. Add chat lines, 24-hour financial networks, financial magazines, and newspapers to the mix, and it’s no wonder that investors are feeling overloaded and confused. We’ve gone from a dearth of information to the extreme of too much information to decipher. Our task has become one of picking through a haystack of data to find (and recognize) the important needles of information. In many cases, we just get overwhelmed and end up doing nothing, because we don’t know how to proceed. If you have this problem, this book is for you! It will detail how to research, sort through the data and analyze it, to find those investment candidates with good profit potential. Over the years, I’ve learned that I can’t know everything. If I try to analyze every stock, I’ll just end up frustrated, knowing a little about a lot. Instead, I specialize in one area, stocks under $5. Doing so eliminates the vast majority of information clutter. That frees me to concentrate on one important goal - finding a bargain. I believe that knowledge is power. This book will give you the tools to make your own educated decision on whether or not to purchase a stock. You won’t have to rely on someone else, who may be more interested in a commission than in the quality of the investment. Making BIG Money in Small Stocks will teach you to analyze a stock on your own, determine a good price for stock purchase, and how to recognize and protect your profit. By purchasing this book you’ve taken the first step. Now make sure that you invest the time and effort to accomplish your goals. After reading this book, you will have a better understanding of the stock market, the economy and the investment process. You’ll have the knowledge to buy quality, low-priced stocks. This is the best investment strategy to fulfill your financial dreams! I welcome your comments on the book and hope you find Making BIG Money in Small Stocks interesting, educational and profitable! Bill Mathews, Editor The CHEAP Investor Mathews and Associates, Inc. 3 Golf Center, Suite 404 Hoffman Estates, IL 60169 (847) 697-5666 (847) 697-5699 - fax Website: www.thecheapinvestor.com Preface vii Dedications To Karen, my wife, partner and best friend. This book is a reality because of your hard work and determination. Thank you. To Allison, Alexander, Jennifer, Kaitlyn, Mallory, Meghan, Olivia and Stephanie. I hope that Making BIG Money in Small Stocks is an inspiration to show that with a goal, hard work and perseverance your dreams can come true. Thank you to Adrienne for proofing, Kat for editing and introducing me to style sheets, and a special thanks to Garrett who created an outstanding book cover. Table of Contents Table of Contents _____________________________________ viii Investing – The National Pastime __________________________ 1 BEFORE YOU INVEST ____________________________________ 2 THE BIRTH OF THE CHEAP PHILOSOPHY __________________ 2 CORNERSTONES OF THE CHEAP PHILOSOPHY _____________ 4 WELCOME TO THE WORLD OF CHEAP INVESTMENTS ______ 8 THERE IS A BIG DIFFERENCE BETWEEN A STOCK AND THE MARKET ________________________________________________ 9 Common Stocks are Your BEST Investment ________________ 11 WHAT IS A COMMON STOCK? ___________________________ 12 TYPES OF COMMON STOCKS ____________________________ 13 Blue Chip Stocks ____________________________________________ 13 Growth Stocks ______________________________________________ 13 Income Stocks ______________________________________________ 14 Fad Stocks _________________________________________________ 14 Cyclical Stocks ______________________________________________ 15 Large-Cap, Mid-Cap, Small-Cap and Micro-Cap Stocks ______________ 16 COMMON STOCKS OFFER EXCELLENT LIQUIDITY ________ 18 COMMON STOCKS POSSESS GREAT PROFIT POTENTIAL ___ 19 RISK VERSUS PROFIT POTENTIAL ________________________ 20 COMMON STOCKS AND YOUR TAXES ____________________ 21 Capital Gains _______________________________________________ 21 USING YOUR STOCK AS COLLATERAL ___________________ 22 Stock Exchanges – The Foundation of the Market __________ 24 UNDERSTANDING AN EXCHANGE STOCK TRANSACTION __ 24 NEW YORK STOCK EXCHANGE (NYSE) ___________________ 25 Listing Requirements for the NYSE _____________________________ 26 AMERICAN STOCK EXCHANGE (Amex) ___________________ 27 Listing Requirements for the Amex ______________________________ 28 REGIONAL STOCK EXCHANGES _________________________ 29 The Chicago Stock Exchange (CHX; formerly Midwest Stock Exchange) 29 Table of Contents ix The Pacific Stock Exchange (PCX) ______________________________ 29 The Philadelphia Stock Exchange (PHLX) ________________________ 30 The Boston Stock Exchange ___________________________________ 30 The Cincinnati Stock Exchange _________________________________ 30 THE NASDAQ MARKET __________________________________ 31 The NASDAQ National Market System __________________________ 31 The NASDAQ SmallCaps Market _______________________________ 32 Understanding a NASDAQ Stock Transaction _____________________ 33 OTC BULLETIN BOARD _________________________________ 33 OTC PINK SHEETS ______________________________________ 34 STOCK INDEXES AND THEIR MARKET EFFECT ____________ 35 Understanding the Investment Process ____________________ 38 WHY A COMPANY DECIDES TO SELL STOCK ______________ 38 SPECIALIZING IN ONE AREA RATHER THAN IN MANY _____ 40 THE GREED/FEAR TRAP _________________________________ 41 PROTECTING YOURSELF FROM THE GREED/FEAR TRAP ___ 43 Analyzing Stocks Easily and Profitably ____________________ 45 FUNDAMENTAL AND TECHNICAL ANALYSIS _____________ 45 Fundamental Analysis ________________________________________ 46 Technical Analysis ___________________________________________ 46 Comparing Fundamental and Technical Analysis ___________________ 50 DELVING INTO ANNUAL, 10-K, 10-Q AND QUARTERLY REPORTS AND PRESS RELEASES _________________________ 51 Annual Reports______________________________________________ 52 Financial Statement __________________________________________ 52 What to Look For in the Annual Report ___________________________ 53 Form 10-K _________________________________________________ 55 Form 10-Q _________________________________________________ 57 Quarterly Report_____________________________________________ 57 Press Releases ______________________________________________ 57 GETTING THE FACTS BEFORE YOU INVEST _______________ 57 FINDING THE NEXT SUPERSTOCK________________________ 58 Mastering CHEAP Stocks _______________________________ 60 TREMENDOUS POTENTIAL VERSUS BLUE CHIPS __________ 61 DIVERSIFICATION IN GRADES OF SPECULATION __________ 63 LOCATING A CHEAP INVESTMENT _______________________ 64 x Table of Contents Listing Stocks for Further Research ______________________________ 65 NASDAQ Stocks ____________________________________________ 66 OTC Bulletin Board Stocks ____________________________________ 66 OTC Pink-Sheet Stocks _______________________________________ 67 Penny Stocks _______________________________________________ 68 THE PITFALLS OF HOT TIPS _____________________________ 68 THREE CRITERIA FOR SUCCESSFUL STOCK PICKS _________ 69 LITTLE COMPETITION MEANS VERY HIGH PROFITS _______ 70 HOW TO FOLLOW YOUR STOCKS ________________________ 71 Mastering Turnaround Stocks ___________________________ 72 WHAT IS A TURNAROUND STOCK? _______________________ 73 Aspect Telecommunications - A Turnaround Stock _________________ 74 THE HUGE PROFIT POTENTIAL OF TURNAROUNDS ________ 74 Investing in a Quality Stock in a Depressed Industry ________________ 75 The Contrarian Approach ______________________________________ 76 IDENTIFYING AND SELECTING A QUALITY TURNAROUND 77 Locating Turnaround Stocks ___________________________________ 77 What to Look For in a Turnaround Stock _________________________ 77 TURNAROUNDS TO AVOID ______________________________ 78 Companies in Industries that are Extremely Capital Intensive __________ 79 Companies That Have an Extremely Large Debt ____________________ 79 Companies That Offer High Percentage Dividends __________________ 80 Companies Affected by Foreign Currency _________________________ 80 Companies That Are Recommended as Hot Tips ___________________ 81 TAKE YOUR PROFITS ___________________________________ 81 Mastering Stocks in Bankruptcy _________________________ 82 BANKRUPTCY (CHAPTER 11) – AN OVERVIEW ____________ 84 LOCATING COMPANIES IN CHAPTER 11 __________________ 85 Companies with Huge Sales ____________________________________ 85 Companies Listed on the NYSE _________________________________ 86 Companies That Are Former “Darlings” of Wall Street ______________ 86 Companies with Widely Known Names or Products _________________ 86 SELECTING BANKRUPTCIES WITH THE MOST POTENTIAL _ 87 Companies That Change Management ____________________________ 87 Companies That Become Profitable ______________________________ 87 Companies That Enter a Prepackaged Chapter 11 ___________________ 90 Companies with a Confirmed Reorganization Plan __________________ 90 TRENDS IN BANKRUPTCIES _____________________________ 91