Trust Penny Stock Picks at Your Own Peril

Have you ever wondered what the deal is with those shady-seeming emails and websites touting various penny stocks?

When a friend recently forwarded me an email from StockTamer, I decided to dig in to the mystery.

It turned out to be even worse than I thought.

Image source: Getty Images.

StockTamer's "About" page spews the same kind of language that most similar sites say:

We spend countless hours researching hundreds of small-cap companies with one goal in mind, finding you the best penny stocks with the largest potential for huge gains, within the OTC Market. StockTamer.com informs you about the break out penny stocks before the OTC market catches on. The StockTamer Report is dedicated to bringing our members new stock small-cap picks ready to make huge gains in the market place.

Sounds like you've got a real research powerhouse working for you, right? Not so much.

The website -- along with Insidebulls.com and Therainingpenny.com -- is owned by The Entourage Group, which describes itself as "a full service E-Marketing / E-Branding & E-PR group." And if you care enough to read the company's disclaimer, you'll find this:

... the Information should not be construed in any manner, shape or form as investment advice, investment recommendations or opinions or viewpoints regarding the Profiled Company or its securities or as a solicitation to offer, purchase or sell the Profiled Company's securities. Stocktamer does not endorse, independently verify or assert the truthfulness, completeness, accuracy or reliability of the Information and conducts no due diligence whatsoever of the Profiled Companies.

And there's more:

We always receive compensation from the third party shareholders in cash and/or compensation in the Securities in connection with preparation and dissemination of the Information, most frequently in the form of Securities in the name of the Profiled Companies. We regularly and routinely sell the Securities before, during and after its dissemination of the Information, most frequently during the dissemination of the Information. You should be acutely aware that we repeatedly sell the Securities while we are engaged (and most often so engaged) in the dissemination of the Information, as well as before and after such dissemination. Many such securities sales occur during the dissemination of the Information often within minutes, hours or days after we first disseminate the Information to the Readers.  

In other words: We will tell you these stocks are fantastic just as we are selling the free shares that we're paid with.

Cashing in by cashing out
While I didn't immediately see details on exactly how much StockTamer is taking in, this business is hardly about pennies.

The Global Equity Report penny-stock site showed that it had been paid as much as $500,000 for a stock "profile" (specifically, for touting Advanced Visual Systems). Six-figure paydays for trumpeting a penny stock doesn't seem unusual either -- the same site had been paid $100,000 or more for hyping numerous other stocks including Lake Victoria Mining, Clenergen, and Wind Works Power.

As if that's not  enough, there are also stock touters paying other stock touters. BlueWave Advisors -- which owns a ridiculous number of penny-stock sites including thehotpennystocks.com, Beacon Equity Research, and thetopinvestor.com -- is listed as having paid thousands to The Global Equity Report to push a handful of stocks. And that's no fluke -- a recent penny-stock email from Penny Stocks Psychic that managed to slip through my junk filter noted that BlueWave paid $12,000 for that site's "advertising and promotion" for the stock it was hyping.

If you think you're the one that's going to get rich in this ugly web then I've got a bridge to sell you.

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If you've ever wondered why penny stock websites are so eager to give you a free subscription, now you know.

"But," you may still be wondering, "aren't there some good companies hiding out in the morass that is the penny-stock universe?"

I'd be lying if I said that penny stocks never make it into the big leagues. Back in 2000 both Iconix Brand Group (Nasdaq: ICON) and Amedisys (Nasdaq: AMED) were tiny, uncertain companies with very low-priced shares. Today, both are profitable companies worth north of $1 billion.

But let's just say that the odds aren't in your favor to begin with, and if you try following the "picks" from penny-stock newsletters your prospects are going to be decidedly worse. Why? Because chances are that the stocks that are the most heavily hyped generally have the worst companies backing them.

Here's a look at the five stocks that StockPromoters.com says have been the most hyped over the past week.

Source: Capital IQ, a Standard & Poor's company.

Not a single one of these companies has created a penny of value for its shareholders. No wonder they need to paid hypers to push their stocks.

That ain't investing, folks
If you've got a gambling itch and want to scratch it by wagering on penny stocks, fine. I prefer horses or cards when I occasionally feel that pull, but to each his own.

However, don't fool yourself into thinking that you're doing anything but gambling when you're messing around with these stocks.  All you're doing is betting that another investor will be dumb enough to buy the shares from you at a higher price.

Ready to give up the penny-stock delusion and actually start investing? Earlier in the month, I highlighted Raytheon (NYSE: RTN), Willis Group, and AstraZeneca (NYSE: AZN) as three stocks on my watchlist. All three appear to "have it all" -- meaning that they're efficient and profitable companies that pay dividends and have a reasonable valuation.

For those looking for potentially higher-growth fare, my fellow Fool Jordan DiPietro recommended three stocks -- including Power-One (Nasdaq: PWER) and Bridgepoint Education (NYSE: BPI) -- that the broad market may be overlooking. And finally, Ilan Moscovitz highlighted Ingersoll-Rand (NYSE: IR) as one of his top 10 Buffett stocks.

So go ahead, slowly back away from the penny stocks and start doing some real investing. To begin, you can keep track of the stocks above by adding them to your watchlist.

• Add Raytheon to your watchlist.
• Add Willis Group to your watchlist.
• Add AstraZeneca to your watchlist.
• Add Power-One to your watchlist.
• Add Bridgepoint Education to your watchlist.
• Add Ingersoll-Rand to your watchlist.