How to Make Money in Penny Stocks

You really can make money in penny stocks!

Maybe not you. Or me. But it is possible (if not legal). And in a moment, I'll show you how it's done.

The new Jordan Belfort
But first, let me give you a sense for how rich you can get. Here's a glimpse at the life of John Babikian, an alleged penny stock "entrepreneur" (ahem):

  • "Babikian owned a Bugatti Veyron -- the cars cost more than $1 million and take 2.5 seconds to hit 60 miles (96.6 kilometers) per hour -- as well as a Bentley and Lamborghini." (Reported by Bloomberg News)
  • "He is believed to possess passports from Guatemala, Lebanon, and Nevis and was last reported -- by his wife's divorce lawyer -- to be in Monaco." (Reported by National Post)
  • "Mr. Babikian's illegal stock pumping schemes reportedly netted him $100 million." (Reported by National Post)
  • "One of Babikian's companies had paid $2 million for 480 acres of Wasco County [Oregon] wheat land and spent another $5 million to turn it into a state-of-the-art vineyard." (Reported by The Dalles Chronicle)
  • "His now-frozen U.S. assets include two houses, one in Los Angeles he reportedly purchased for $2.2 million, an agricultural property in Oregon, and an ownership stake in a private airplane." (Reported by National Post)

As my cheeky headline suggests, you really can make money in penny stocks -- not by trading in and out of low-quality stocks, but by illegally pumping and dumping them!

John Babikian is on the lam. His U.S. assets were frozen by the SEC. He may be in Monaco -- he left Canada amid tax-evasion allegations there -- but the SEC says his whereabouts are not known.

The opt-in newsletter site that made him rich, AwesomePennyStocks.com, shut down last fall (claiming to have had an "AWESOME run" -- get it? -- over the past few years). Awesome Penny Stocks may have been an unusually successful pump-and-dump operation, but it's hardly alone.

GOFF (OTCBB: GOFF), the touted stock I wrote about last year, was pumped by PreferredPennyStocks.com, which used the same playbook as AwesomePennyStocks.

These sites buy digital advertising to lure people onto their email lists. According to a Motley Fool analysis using WhatsRunWhere, a competitive intelligence service for online ad buying, from 2009-2012 AwesomePennyStocks ran display ads on nearly every major investing website around -- Barrons.com, TheStreet.com, Yahoo! Finance, CNN Money, et al. -- and even major non-finance sites including ESPN.com, Time.com, and Golf.com. (AwesomePennyStocks didn't do individual ad deals with these properties; it bought the placements from an ad exchange that was used by these sites.)

Investors in the U.S., Canada, Australia, and the U.K. were targeted. Here's a typical example of one such display ad:

It's important that these stock touts are done through email newsletters -- because users are giving permission to these firms to send them stock tips.

As OTC Markets Group CEO Cromwell Coulson told Bloomberg News, "The traditional Stratton Oakmont has been replaced by the opt-in newsletter." (Stratton Oakmont, the infamous boiler room operation, was memorialized in Martin Scorsese's The Wolf of Wall Street.)

The case of GOFF
Last year, I explored other deceptive measures penny stock scammers use to dupe retail investors in pump-and-dump schemes -- including paying analysts for research reports, placing articles on investor websites, using fake celebrity Twitter feeds, and more.

GOFF, the focus of that article, at one point traded for $0.65 in the spring of 2013. Today, it's at $0.0048; the penny you find in a parking lot is twice as valuable as a share of this company.

In spite of my warnings, trading volume in penny stocks last year hit its highest level since 2007, according to Leuthold Weeden's Doug Ramsey. Part of that, to be sure, has to do with investor overconfidence from the multi-year bull market.

But a major culprit is the opportunism of penny stock scammers like Babikian. In 2013, 1.9 trillion spam messages went out in just one month. "A major factor in spam's giant comeback," CNNMoney reported, "is a significant increase in so-called 'pump-and-dump' scams."

And these scams are getting more sophisticated. In a study of investor reaction to stock spam messages, Professors Karen Nelson, Richard Price, and Brian Rountree found that "investors appear to ignore spam messages that are nothing more than vague puffery."

Professors Nelson, Price, and Rountree's study, "Are Individual Investors Influenced by the Optimism and Credibility of Stock Spam Recommendations?" published recently in the Journal of Business Finance & Accounting, explains how the likes of Awesome Penny Stocks and Preferred Penny Stocks are able to lure investors into trading obscure, illiquid stocks:

"The market response to spam is concentrated in the subset of stocks targeted by spam emails containing target prices and old press releases. Moreover, investors do not simply consider a single attribute of the message, but rather are most effectively swayed by the combination of these attention-grabbing devices, even in the presence of a disclaimer by the spammer." [emphasis mine]

Including a (1) target price alongside (2) a press release appears to be the magic formula. Investors anchor on the optimistic implied return without giving much credence to the fact that the press release could be days, weeks, or even months old. The professors found that these techniques work even if there is an honest disclosure section at the bottom detailing real or potential conflicts of interest.

Let's return to GOFF for a moment to see this in play. I received the following spam message from Preferred Penny Stocks on Sunday, April 7, 2013. The subject line read, "Huge News Could Shoot GOFF to $2 Range Quickly!"

On Friday GOFF announced that it has reached an agreement to acquire additional gold projects in Marmato that could hold as much as 20 Million ounces in potential gold!

For those of you without a calculator that's about $30 Billion in potential gold reserves based on Friday's gold price of USD $1581.30.

Here's an excerpt from the press release: "Previous drilling has been carried out on the Gavia Property (newly acquired leases by GOFF), and revealed gold grades averaging about 1 gram per ton. Historical data indicates the Gavia Property has gold potential of over 20 million ounces, based on mapping, soil samples and existing tunnels."

This acquisition will put GOFF on the map as an exploration mining company with tremendous upside and attract potential joint venture or merger opportunities.

There is a huge amount of potential gold waiting to be discovered by GOFF on its new leases. Even if only a fraction is recovered from GOFF, shares could stand to soar from these levels!

Short sellers that were shorting GOFF all of last week could get squeezed to death from the potential for new buyers that many expect to come on Monday. These groups may have to purchase back literally millions of shares on the offer which could potentially catapult GOFF over the $2 mark.

Why be the guy on the sidelines when you can be the guy that took home the prom queen? [emphasis in original]

A similar message was sent out to subscribers of Awesome Penny Stocks, PennyStocks.com, and, no doubt, other penny stock newsletters.

I was unable to find the press release quoted in the above email (purportedly released on April 5, 2013), but a verbatim version was issued on April 22, 2013, and now lives on PRWeb.

You'll quickly notice a few things about this GOFF message -- besides the ridiculousness of that last line. First, it beautifully illustrates what Professors Nelson, Price, and Rountree found -- investors are susceptible to spam that packages a target price with quotations from a press release (because only trustworthy companies issue press releases, I guess?). GOFF closed at $0.58 on Friday, April 5, 2013. After the emails went out over the weekend, the stock opened 9% higher on Monday.

Also note that the target price of $2 is ambitious -- from that $0.58 closing price, it's an implied return of 245% -- but not absurd. The professors found that "as target prices become excessively optimistic, trading in the targeted stock is dampened."

The stock touters try to create an illusion of believability, without dampening the beyond-the-shadow-of-a-doubt bullishness conveyed within the email message.

These are their tricks. You are their (potential) prey.

These schemes are complex, but replicable.

That's why the judge who issued Babikian's asset freeze said there is a high risk "that, unless enjoined, Babikian may commit the alleged fraudulent acts again, given his control of penny stock websites and his aptitude at using anonymous email accounts, alter-ego front companies, and mass email distribution systems."

If you want to commit your investing dollars to trading in and out of penny stocks ... these are the type of people on the other end of your trade.

There's a poker saying that if you can't spot the sucker in your first half hour at the table, then you are the sucker.

If you're thinking of speculating in penny stocks you've seen hyped on the Internet, remember this: you're probably the sucker.


Read/Post Comments (14) | Recommend This Article (32)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 30, 2014, at 12:53 AM, michaelkm88 wrote:

    I'm sorry, this must have been a backdoor advertisement for the motley fool services no? I think yummy lead e with the wrong foot.

  • Report this Comment On April 30, 2014, at 1:05 AM, michaelkm88 wrote:

    How about this one...

    Why I'm Investing $117,238 In This Stock

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    This company is growing faster than Apple, Amazon.com, and Google combined. In fact, I’m so confident about its profit potential that I officially promised our legal team I would invest five times more than I own in any other stock. And hold it until at least January 2018. But I’d rather not go on my million-dollar quest alone… so I’m inviting you to join me! You don’t have to invest $117,238. But whatever amount you choose to put in, I advise you to do it NOW.

  • Report this Comment On April 30, 2014, at 1:07 AM, michaelkm88 wrote:

    Or this one...

    R.I.P. Internet -- 1969-2014

    At only 45 years old... the Internet will be laid to rest in 2014. And Silicon Valley is thrilled. Because they know... The Economist believes the death of the Internet "will be transformative." In fact, the CEO of Cisco Systems -- one of the largest tech companies on the planet -- says somebody's going to bank "14.4 trillion in profit from one concept alone." Click here for a FREE video that gives you what you need to capitalize on the little-known company behind this concept.

  • Report this Comment On April 30, 2014, at 1:19 AM, michaelkm88 wrote:

    This is an ad on the monthly fool. Sounds pretty good... kind of like a scam.

    50% Returns In 3 Months

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  • Report this Comment On April 30, 2014, at 1:24 AM, michaelkm88 wrote:

    This is a good one as well.

    The Death of Credit Cards

    The plastic in your wallet is about to go the way of the typewriter, the VCR, and the 8-track tape player. When it does, a handful of investors could stand to get very rich. You can join them - but you must act now. An eye-opening new presentation reveals the full story on why your credit card is about to be worthless - and highlights one little-known company sitting at the epicenter of an earth-shaking movement that could hand early investors the kind of profits we haven't seen since the dot-com days.

  • Report this Comment On April 30, 2014, at 3:01 AM, Interventizio wrote:

    michaelkm88 you're show was excellent you should be selling tickets next time.

    Of course, the article talks about penny stocks, and Fool won't ever advise buying this sort of stocks.

    Wish you better luck next time you feel the need to lay s***t on someone's honest work.

  • Report this Comment On April 30, 2014, at 3:01 AM, Interventizio wrote:

    michaelkm88 you're show was excellent you should be selling tickets next time.

    Of course, the article talks about penny stocks, and Fool won't ever advise buying this sort of stocks.

    Wish you better luck next time you feel the need to lay s***t on someone's honest work.

  • Report this Comment On April 30, 2014, at 8:56 PM, DAVE335i wrote:

    Can someone tell me why all of that is not fraud? Why don't they just shut down the OTC markets, or if your company isn't making or attempting to make real profits. Go straight to jail for fraud.

  • Report this Comment On April 30, 2014, at 8:59 PM, DAVE335i wrote:

    How about some ethics Motley. You sell ad space to these firms, helping them cheat honest people. If companies in this country were held accountable, maybe it would be harder for them. Or did you guys skip business ethics class.

  • Report this Comment On April 30, 2014, at 10:52 PM, TMFBrich wrote:

    @michaelkm88:

    You seem like a smart guy so I'll assume you understand the difference between Motley Fool advertising and ads for a penny stock newsletter whose sole purpose is to pump and dump worthless penny stocks.

    Re: your comment about RealForexProfits -- where did that appear? In the "sponsored links" below?

    I've alerted our ad sales team to have it removed. We have a filter so that junk like that won't show up on Fool.com, but it's not 100% effective.

    Regards,

    Brian Richards

  • Report this Comment On April 30, 2014, at 11:15 PM, TMFBrich wrote:

    @DAVE335i:

    You asked, "Can someone tell me why all of that is not fraud? Why don't they just shut down the OTC markets, or if your company isn't making or attempting to make real profits. Go straight to jail for fraud."

    Pumping and dumping is fraud -- that's why Babikian had his assets frozen! See this link: http://www.finra.org/Investors/ProtectYourself/InvestorAlert.... "More than a decade ago, the SEC created the Office of Internet Enforcement specifically to fight Internet fraud, including schemes using spam...."

    As for shutting down the OTC markets or forcing companies to aim for profits -- that would be tossing out the baby with the bathwater. The market does a mostly efficient job at not allocating resources to those types of companies, anyway.

    You also wrote, "How about some ethics Motley. You sell ad space to these firms, helping them cheat honest people. If companies in this country were held accountable, maybe it would be harder for them. Or did you guys skip business ethics class."

    To be clear, and as I state above, Awesome Penny Stocks bought ad inventory through an ad network -- it didn't strike deals with individual sites.

    According to the WhatsRunWhere analysis mentioned in the story, an APS ad ran on a co-branded MSN-Motley Fool CAPS page.

    While that's disappointing to me, per our analysis, none of the ads ran on Fool.com itself. Our TMF ad sales team has screens in place to filter out low-quality ad partners. As I said in the above comment, it's not 100% effective at all times, but we do have filters in place for these types of advertisers.

    Regards,

    Brian Richards

  • Report this Comment On May 02, 2014, at 11:00 AM, borneofan wrote:

    I must admit that the Fools longwinded stories can appear similar to pump and dump ads.

    I guess I don't expect MF to be as pure as the driven snow or I would have abandoned it long ago. Repeated exposure has immunized me to this weakness of mine, much like an involuntary resistance training regimen. Scared straight for investors.

    Besides, a part of me wants and expects that people who combine greed and stupidity to suffer. I have a hard time justifying expending taxpayer dollars protecting people from their own worst instincts. Just when you think investing has been safety sealed and foolproofed, you meet a greater fool.

    There's a sucker born every minute. One trip to the school of hard knocks is an excellent cure.

  • Report this Comment On May 02, 2014, at 2:04 PM, Flyboy32 wrote:

    I agree with borneofan. Some of the very long video clips I get from Motley Fool are very convincing and appear to go against what Motley Foot stands for. I always wonder how much these stocks go up after the long recommendation, and how many people are in front of us and have already bought into these companies before we do. I guess it really does not matter too much if you hold on to the stock for the long run.

  • Report this Comment On May 02, 2014, at 3:10 PM, FoodLong wrote:

    The reason penny stocks are a bad idea and probably will always be is really quite simple:

    Accounting, It's just not there in any sort of legitimate fashion. Without credible accounting how could you ever purchase stock in a company?

    The only possible way I could ever see buying a penny stock is if I knew the people who owned the company on a personal level. I.E. I went to school with them or they were childhood friends or something.

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