Understanding How the Game is Played

A few days ago, a subscriber to my REVERSE TAKEOVER PROFIT HUNTER asked me a few questions about an investment he made after receiving my email buy alert. I could not answer his questions because doing so would constitute soliciting investment advice. And, since neither Lombardi Financial nor I are a registered dealer/broker, giving specific investment advice is also against the law.

Still, I felt bad not being able to help this subscriber. So, I decided to write about some of the basic premises of the game and how the relationship between my subscribers and I is supposed to work.

As it turned out, the subscriber in question bought a stock that very recently went through a reverse takeover. However, the price he paid for the stock was more than 50% above the price at which the alert went out. The next trading session, the stock moved and I issued a sell alert. By that time, the sell alert meant very little to my subscriber. As a result, the subscriber asked questions about how I came to recommend the stock in the first place, what has changed from either the fundamental or technical point of view to prompt issuing the sell alert, and what he should do going forward.

Now, customers who have been subscribing to my REVERSE TAKEOVER newsletter for a while know that I always include editorial articles, which are mostly of an educational nature. They also know from these articles that, more often than not, I cannot provide a thorough fundamental or technical analysis.

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The reason is simple. Stocks that I recommend usually do not have enough of a trading history for technical analysis, nor have they yet made its financial results public to give me more insight about their fundamentals. Please note, that describing what a company does, and commenting on the overall performance of a sector the company is in, does not constitute fundamental analysis. Plus, in the case of the stock I am talking about, its “history” was really, really short. The company completed the reverse takeover only about a month ago, while the name and symbol change became effective just days before my buy alert went out.

So, how do I come up with a recommendation for companies that have gone through a reverse takeover? Typically, having no reliable fundamental or technical analysis to go on, I research whatever information is publicly available on the company, including information on the public shell that has served as a vessel of going public. I also study the industry and sector that the company is in. When this is put together, and if I believe there is potential for profit, an alert is sent out.

Of course, there is also a factor of novelty here that has to be taken into account. Although reverse takeovers garner much less fanfare than initial public offerings, investors in the market for newly public companies pick them up on their radars as well, thus creating additional buying pressures.

At this point, I must emphasize that Lombardi Financial is not a promoter of any company that has been recommended in any of our portfolios. In fact, we are neither paid by the companies that we recommend, nor are any of the editors allowed to own any stock in his/her personal portfolio for 30 days after issuing a buy alert. The idea is to avoid conflicts of interests that are a surefire way to place our subscribers in a disadvantageous position.

Going back to fundamental and technical analysis of most reverse takeover stocks, or rather the lack thereof, aside from having no trading history to fall back upon, or history of being a public company for that matter, for stocks that have just begun trading on an over-the-counter market, I am reluctant to provide any guidance with respect to entry and exit points. Here is why.

Over-the-counter markets are tricky. I wrote in detail about the Pink Sheets in the June 2006 newsletter. There is also an editorial about calls to overhaul OTC markets in the April 2006 issue, while in the January 2006 issue, I wrote about how public shells have come under increased public and regulatory scrutiny. The gist of such editorials is this–over-the-counter markets are notoriously lacking in transparency.

Here is an example of how an OTC trade would usually work. Let’s say that an investor wants to buy 10,000 shares of a penny stock ABC Inc., which is currently both bid and asked at $0.15. The investor calls a registered person (either a full service broker or a discount broker) with his buy order. Then, the registered person calls a market maker in ABC Inc. to ask how many shares are available and at what price. (Bear in mind that the publicly posted price may or may not be the actual price the market maker in the stock is willing to buy or sell it for.)

The market maker then gets back to the broker with the asking price of $0.17, while the broker reports back to the investor, who then has to make a decision whether this is the price he is willing to pay for the stock. Of course, I am not calculating in here any transaction costs. As you can see, when it comes to determining an entry or exit price of an OTC traded stock, there are too many variables for anyone outside the market makers’ circle to provide reasonable price guidance.

Now, the investor in the above hypothetical example may decide that a spread between the posted and quoted price of about 13% is not too much of a premium to pay. Returning to the price my subscriber has paid, which was at the premium of about 54% above the alert price, this is certainly too high, especially considering that we are always urging our subscribers to make sure their stop loss limits do not exceed 30%. Yet, that was the investment decision he chose to make.

This brings us to the issue of how the relationship between me, editor of several financial newsletters, and my subscribers is supposed to work. I cannot stress enough that I am not your broker nor a registrant licensed to solicit investment advice. My responsibility is to find interesting companies, which, at times, can be equated with finding a needle in a haystack, pluck them out of obscurity, and provide you with as much relevant information as I can find, along with my personal opinion about the investment. I will venture here and say that new investment ideas are the commodity I “trade” in.

However, at that point, my job is also done. The rest, whether to invest or not, at what price, when to enter and exit, how much to buy, is the stock even acceptable at your risk level and to the structure of your portfolio, etc., is entirely up to you to decide. Some among you utilize brokers, while some are quite proficient stock researchers themselves. But, in the end, only you know what the best course of action in your situation is, and only you can decide what to do with my investment idea.