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With
the stock market in tatters throughout the past 18 months, it's not
surprising to find lots of low-priced stocks to choose from. More stocks
on the Russell 2000 trade at $10 or less than at any time since the
recession of 1990-91, mostly owing to the demise of the dot-coms and the
collapse of the telecoms. More startling, 326 sub-$1 stocks litter
Nasdaq's landscape -- close to 9% of the 3,736 domestic common stocks
listed as of Feb. 28 on the "Stock Market for the Next Hundred Years."
Of that, 202 companies are on the National Market, a total equal to 6.6%
of the companies listed there, according to the Center for Research in
Security Prices at the University of Chicago. The rest reside on Nasdaq's
Small Cap Market, where you might expect to find cheap stocks, but not
penny stocks. Many of those companies have languished below a buck for
much of the past year and many remain unprofitable with uncertain
prospects.
Nasdaq is the second-biggest stock exchange in the U.S., behind only the
New York Stock Exchange (which has stricter listing standards and where
fewer than 2% of its stocks are trading under $1). By continuing to list
penny stocks, Nasdaq may be laying a trap for small investors lured by the
shares' sheer affordability and by casino dreams of big payoffs. It also
may be avoiding an inevitable question: How have so many of the stocks it
has listed soured so seriously, and often so swiftly?
Five to 10 years ago sub-$1 stocks would be pink-sheet stocks; now they're
all trading on Nasdaq. Penny stocks are more easily manipulated. Indeed,
many traditional money managers have mandates that prevent them from
owning stocks under $5.
The most important thing to look at is not how many are trading below a
dollar, but how many have done so for 30 consecutive trading days. But
after the terrorist attacks on Sept. 11, Nasdaq imposed a moratorium on
delistment and stopped enforcement actions to allow executives to focus on
running their businesses. That helps explain why even stocks that had been
trading below $1 for much of last year continue to be listed. The
moratorium ended Jan. 2.
Nasdaq says there are "elaborate hearings and an exhaustive process"
before a company is delisted. If a company's stock trades below $1 for 30
straight trading days, Nasdaq sends the company a warning and gives it 90
calendar days to become compliant. During that period, if a company's
stock closes at or above $1 a share for 10 straight days, the cycle begins
again and the stock would have to trade below $1 for a new round of 30
consecutive trading days before Nasdaq would take action. At that stage
many companies announce recapitalization plans and reverse stock splits in
an effort to boost share prices above the minimum threshold.
By avoiding draconian measures and by delaying action, Nasdaq is clearly
betting some companies will benefit from a turnaround as business
improves, and mergers and bankruptcies will likely remove other companies
and the need for exchange action.
Nasdaq is also free to exercise discretion. The suspension provision says
only that Nasdaq "may" delist a stock.
Individual investors tempted by cheap stocks should think twice. A study
conducted last November, came to this stern conclusion on whether
individual investors should buy stocks priced below $10 a share,
particularly those below $5: "Clients should not touch them."
Study determined that the average annual return over the past 11 years of
stocks on the Russell 2000 index priced below $5 was a loss of 5.8%; most
of the poor performance came in the first three months of 2001, when
stocks under $5 lost an average of 49.9%. Stocks trading above $10, on the
other hand, gained 10.3% and topped the index average in all but two
years.
For investors who insist on speculating in such cheap stocks, landing a
winner can result in a big payday. Of the outperforming stocks under $10
in the study, 16.5% did so by more than 40%.
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