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Penny stocks can either make or break your portfolio. In this weekly series, we'll look at the heartbreakers, the hypesters, and the stocks destined to disappoint, and then close with better alternatives for your portfolio.
Pinched by pennies
First, let's talk about why you want to avoid most penny stocks. Last year at this time, 3,377 stocks listed on U.S. exchanges were trading for $5 or less, and worth between $5 million and $1 billion in market cap, according to Capital IQ. Of those, 1,630 declined in value over the past year -- during a rally in which the overall market rose more than 6%.
It shouldn't surprise you that Pink Sheet issues are some of the biggest losers -- or that the companies behind these thinly traded stocks are stock promoters' most frequent clients. They pay these hypesters a fee to produce "research" intended to encourage you, the sucker -- I mean, investor -- to buy shares.
We don't want you to fall for these shenanigans. To help, we're going to deconstruct one potential scam per week, with help from Motley Fool Hidden Gems co-advisor Seth Jayson, Motley Fool CAPS majordomo John Keeling, and their TMFStockSpam CAPS portfolio.
Let's meet this week's miscreant: Resources Exchange of America.
Unlike our last miscreant, Tootie Pie, what Resources Exchange does isn't clear from its name. Here's how stock promoter Exceptional Picks positions the business: "The management team at Resource Exchange of America Corp. has targeted a number of strong, but undervalued, asset recovery firms, processing and sorting yards and scrap metal brokers for acquisition in 2010 and 2011. Negotiations are already under way -- this team knows that it's the perfect time to act on Buffett's wise words." [Emphasis added.]
Wowsa. I mean, look at all those code words:
- Negotiations are under way!
If only there were a track record behind the rhetoric. According to Capital IQ, Resources Exchange was called Mobieyes Software before it changed its name in February. Yep, February. Six freaking months ago.
Mobieyes, as you might imagine, wasn't a recycler. According to this 8-K filing, the company was incorporated in January 2009 to create "mobile enterprise software" to help improve the productivity of field sales personnel.
Not surprisingly, the strategy failed. Oracle (Nasdaq: ORCL ) , salesforce.com (NYSE: CRM ) , and NetSuite (NYSE: N ) all offer smartphone apps for on-the-go salespeople. So instead of swimming upstream like a salmon doomed to die, Mobieyes merged with recycler UTP Holdings and became Resources Exchange. Bye-bye mobile enterprise software, hello recycling.
Inside the head-fake
Can you spot any other problems with this pitch? Experience is a huge one. Performance is another. The only available income-statement data in Capital IQ shows revenue plummeting from $5.1 million in 2008 to $1.6 million in 2009.
To be fair, those figures may be for Mobieyes or UTP. Either way, I still think they're telling. Resources Exchange's one and only quarterly report, filed in June for the period ending on April 30, shows a massive net loss on an 88% drop in revenue. Acquisitions and partnerships may right this equation to a degree -- the company has announced many -- but this still looks like a death spiral.
There's also the matter of Exceptional Picks, the promoter, which distributes through an entity called GreenBull Stocks (GBS). Tens of thousands of dollars changed hands before this so-called recommendation reached my inbox.
"Sobini Capital International LLC has paid $10,000 for this advertising effort. GBS was paid $10,000 dollars and GBS expects to generate new subscriber revenue, the amount of which is unknown, to its newsletter through the distribution of this advertising piece," reads this disclaimer.
Is there a story here?
But I promised you more detail about legitimate enterprises in the recycling space. Alcoa (NYSE: AA ) could top the list, since it invented the idea of metals recycling back in 1888, and to this day operates a joint venture called Alcoa Recycling.
- Waste Management (NYSE: WM ) is another possibility, thanks to a subsidiary that operates 109 material recovery facilities in the U.S. But two lesser-known stocks my Foolish colleague Jordan DiPietro profiled recently might be even better than these:
- Darling International (NYSE: DAR ) , which recycles animal carcasses for creating oils, fats, and proteins for animal feeds and other consumer products. Ugly though it may be, there's little chance that technical innovation will disrupt this business.
- Sims Metal Management (NYSE: SMS ) , which is already the company that Resources Exchange hopes to be -- the world's largest scrap-metals recycler.
Of these two, I like Sims Metal best. It boasts a healthy balance sheet and historically strong cash flows, which were funding a 1.1% dividend yield as of this writing.
Now it's your turn to weigh in. How would you invest in the recycling industry? Discuss in the comments box below.