Spam Works

Oh, dear. If you, like me, have been waiting for the junk mail that clogs up your email inbox to just go away, you might want to stop holding your breath. I recently ran across a good reason why spam may be here for longer than we'd like. You see, it seems that ... it works!

The kind of spam I'm referring to here is stock-tip spam. You've most likely seen its kind before. Let me share with you one example I recently received. To visualize it correctly, note that it sported some huge font sizes, along with much bolding, semi-random capitalization, and underlining for emphasis.

Let's pretend that the email I received was hyping a company called Home Surgery Kits (ticker: OUCHH). I'll also fictionalize some of its numbers -- but my points will remain the same. It started out by saying that OUCHH (the message referred to the company solely by its ticker symbol) is paying down its debt and will be profitable by the second quarter of 2007. It said the company's current market capitalization was "$850,0000." (Yes, you read that last zero right.) It stated that that the company is "a absolute steal" at its recent price level, especially considering that it has more than $35 million in revenues and is expected to rake in more than $45 million in fiscal 2007. Its stock price was expected to "easily see a move past $1.00 near term" and "it has major room for a breakout."

Sound exciting? Well, calm down. Sure, maybe it has revenues of $35 million. But that doesn't mean it's a moneymaker. Its net income for fiscal 2006 was negative -- a loss of several million, up considerably from 2005's loss of more than a million.

I received this email on Dec. 1. Two days earlier, the stock had been trading for around $0.40 cents per share. At the end of the day on the 1st, the stock was around $0.93 per share. Some three weeks later, it sat around $0.42. See what happened? Hype, surge, sell, implode. It's a common pattern with these penny stocks that causes many people to lose money.

Professor Laura Frieder of Purdue University's Krannert School of Management and Dr. Jonathan Zattrain of Oxford University studied such spam mails and concluded, "These spam schemes rarely make money for anybody but the spammer." Here's how they typically work, according to an article about Frieder from Purdue:

"The lure of the stock spam scheme is as old as stock speculation itself: Buy low and sell high. The difference is that, in many cases, it was the spammer who buys shares of penny stocks and then promotes the stock in e-mails. If even a few dozen investors pick up on those stocks, the momentary uptick creates a windfall for the spammer, who in many cases sells to the unwitting online buyer."

Think about it. If you buy $1,000 of a 10-cent stock and you illegally hype it up to a value of 50 cents, you can make a pretty penny, and you can profit just before the stock crashes on all of the people who drove the price up for you. This is not the most noble way to make a living.

As Frieder explained, "By the time an investor realizes that the increase in stock price is the result of a phony and orchestrated campaign, it is too late to get out without taking a loss."

It seems that some 730 million pieces of spam are emailed each week, and about 15% of them -- around 100 million -- are touting penny stocks. Frieder found that "stocks experience a significantly positive return on days when they are heavily touted via spam and on the day preceding such touting. ... [On] days when there is touting activity, the probability of a touted stock being the single most actively traded stock in our sample is 81%."

Innocent victims?
An interesting side angle to the study is that the managements and owners of the companies whose stocks are hyped in stock spams don't generally profit -- but they can end up suffering. Investors who lose money blame the companies, even though they didn't send the email in question.

The most obvious victims, though, are the investors who lose money in these scams. But I should really refer to them as speculators, since they don't exhibit the habits of smart investors, such as studying a company first and having reasonable criteria before buying and reasonable expectations from investing.

Don't let yourself fall prey to promises of easy riches via emails. You won't be the one getting rich.

Instead, look to get rich slowly, perhaps by investing in some solid, growing companies. Check out, for example, the average annual growth rates for these well-known companies over the past decade.

Of course, past performance doesn't guarantee future results. If you're interested in finding some compelling investments that our Fool analysts think will appreciate for you over many years, I invite you to test-drive one or more of our rather successful investment newsletters. Our Stock Advisor newsletter, for example, is sporting average returns that more than double the market's return. FedEx is one of that service's recommendations. Check it out, and see for yourself.

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Longtime Fool contributor Selena Maranjian owns shares of McDonald's. The Fool has a disclosure policy.