Steve M. in Daytona Beach, Fla., is an old-fashioned guy. You can tell it by the handwritten note he sent me about a stock tip he received in the mail.
It was about a company called Quest Water Global Inc. (QWTR), and the world’s looming “water crisis.”
“Don’t know if it’s a good investment,” Steve wrote. “Current price is $1.10 but the target price is $6.00 If I ever could get some extra money, I thought it would be good to invest in Quest Water Global.”
That is precisely how stock touts and hucksters do their job, and why people pumping the stocks succeed in a world where it should be pretty easy to avoid scams and schemes.
With just a few questions, even low-tech Steve could figure out that Quest Water Global is a bad bet.
Truth be told, the same could be said for countless issues that are the subject of snail-mail marketing campaigns, spam emails and other pump/dump pitches. There’s a rogue’s gallery of similar stinkers out there, forgettable names like Tuffnell Ltd., Striker Oil and Gas, Amish Naturals and many, many more that all trade now for less than a penny per share, if they trade at all.
It should be easy to make Steve believe that Quest Water Global is headed for the same fate just by telling him to do a simple Internet search, where it’s easy to find that the securities regulators in British Columbia halted trading for the first three weeks of August because they believe “circumstances exist or are about to occur that could result in other than an orderly trading of the securities of Quest.”
While the trading ban did not extend to the U.S., any activity of this type between a company and a securities regulator is a huge red flag.
For their part, Quest officials – who did not respond to requests for comment – issued a statement after the regulator’s order, saying that it stemmed from all of the stock promotion games being played.
All of that unusual activity should, by itself, rain out the game here. Stop the Internet search, trash the flyer, and call it a day.
Moreover, you don’t need to read the company’s quarterly report, where you’ll see that there’s some nervousness over Quest’s ability to remain a going concern, to have some worry that this stock might not keep going.
But Steve – and many investors like him – isn’t going to search the Internet. Guys who handwrite letters to columnists typically don’t have an email account, much less a computer.
So to help Steve and others answer the question of “Is this worth my investment dollars?” you must come up with a smell test.
Here are three questions that represent a test for the average investor who gets a hot tip on a stock.
1. What do the balance sheet and income statement say?
Investing is a bit like sports, where the story of a team is told in big type, but the underlying details are visible in the box score. Don’t trust a story until you see that it reflects the underlying numbers. Even an investor with no computer is going to place an order with a brokerage firm; ask to see the financials before buying.
In Quest’s case, a look at the balance sheet shows that the company had limited cash on hand as of June 30, with major debt and negative shareholder equity. That’s the basic definition of “insolvent.”
Now throw in revenues of $0 – for the entire history of the company – and losses of about $3.5 million during the first six months of 2012, and the picture is particularly ugly.
2. What do the disclosures say about the sales pitch?
Average investors frequently speak with disdain about commission sales, where someone only gets paid when the customer makes a purchase, but what’s much worse and more nefarious is pre-paid hype, where a newsletter editor, website publisher or adviser sells their credibility, taking money to disseminate information.
They surrender both their objectivity and responsibility. The result is a promotional piece like the one Steve got in the mail, where the fine print makes it clear that the newsletter editor was paid a big chunk of change to simply babble up the best-case scenario of the stock promoter, management or both.
3. What are the reasonable alternatives?
One common thread in virtually all of these promotional situations is that there’s a good story about a resource (water in Quest’s case) or some special technique or service that will make a difference, and that you can buy cheaply, and with the promise of faster gains than with big, established players.
But if the alternatives in the business look better, they probably are. At the least, if there are higher-quality players to choose from, look beyond the sales pitch to see what else your money can buy.
For instance, shares of exchange-traded fund PowerShares Water Resource Portfolio are more expensive than Quest Global Water, but an investment in Quest is much more likely to run dry.Chuck Jaffe is senior columnist for MarketWatch. He can be reached at firstname.lastname@example.org or at P.O. Box 70, Cohasset, MA 02025-0070.