High Hopes, High Risks Go With Buying Penny Stocks

If people didn’t like bargains, there wouldn’t be much of a market for the so-called “penny stocks,” those issues which generally trade for a few bucks or less per share.

“I love to have one in my portfolio because I have people who call and ask for them,” said Cal Mead, a broker with E.F. Hutton & Co.’s Costa Mesa office. “I love to have one because they satisfy a need. If all I sold was IBM, I’d be out of business.”

Penny stocks can be traced to the heady Gold Rush days of the last century when public offerings of cheap stocks were used to finance small mining companies, most of which went belly-up, leaving investors in the lurch.

Indeed, many contemporary penny stocks are still in minerals and energy-related firms, and a large number of them are taken public by brokerage houses based in Denver, Salt Lake City and Vancouver, the traditional centers of the penny stock market.

For speculators, the appeal is that the stock which is bought for a fraction of a point today may be sold tomorrow for several dollars. Consider, for example, Environmental Diagnostics Inc., which recently left Irvine for North Carolina.

Environmental Diagnostics, whose chairman is former Interior Secretary James G. Watt, went public in 1984 with an offering of 2.75 million units of stock and warrants at $1 each. Closing at a bid price of 62.5 cents a share the day the offering became effective, Environmental Diagnostics stock has increased more than 300% in value to its current bid price of about $2.625 a share.

Of the nearly 150 public companies headquartered in Orange County, a high percentage sell for less than $2 a share. Among them is Luther Medical Products Inc.

The Santa Ana-based firm went public in 1980 with an offering of 1.9 million units of stock and warrants at $1 a unit. After a 10-for-1 reverse split in 1983, Luther traded for $3.25 a share bid, but recently the stock has fallen to bid price in the range of just 62.5 cents a share.

Another interesting cheap stock--though technically not a “penny stock,” is Irvine-based Strong Point Inc., believed to be the only public company whose main business is prostitution. Founded in 1984 to buy real estate, Strong Point has sold for as little as 50 cents a share but currently is trading at a bid price of about $2.25 a share.

Already the owner of Sue’s Bordello in Elko, Nev., Strong Point has been in the process of acquiring the famous Mustang Ranch for the last year. When the company announced the purchase a year ago, Strong Point hit $3.25 a share.

Some firms such as CompuSave Corp. and Helionetics Inc., both of which recently filed for bankruptcy protection, didn’t plan on becoming penny stocks.

CompuSave, whose stock traded for as much as $10.625 a share last year, fell rapidly in price as the Irvine maker and promoter of video shopping terminals lurched toward its Chapter 11 bankruptcy. Nowadays, you can buy a share of CompuSave for 12.5 cents.

Similarly, Helionetics, whose board read like a “who’s who” of the defense business, might have seemed like an attractive issue at its all-time high of $29 a share. But, continued losses for the Irvine-based laser research firm took their toll, resulting in Helionetics filing under Chapter 11 and getting bounced from the American Exchange. On Friday, one brokerage house quoted Helionetics at a bid price of 37.5 cents a share.

Although every investment maven seems to know of at least one penny stock that went on to make the New York Stock Exchange, losers clearly outnumber winners. And, while buying penny stocks is little more than a craps shoot most of the time, experts say smart speculators can reduce the risks inherent in the low-priced securities.

First and foremost, because most cheap stocks are issued by obscure, poorly capitalized companies, researchers at major brokerage houses aren’t likely to pay much attention to them. Consequently, experts say, speculators had better do their own homework.

“Read the prospectus,” says Peter Betuel, publisher of the Penny Stock Journal, one of several publications devoted to the market. Although reading the prospectus often is all it takes to avoid getting taken, Betuel admits that “most investors are not prepared to do that.”

If a stock still looks attractive after reading the prospectus, investors should use a trustworthy broker who will secure at least three bids from competing market makers in the stock, suggests Larry Butler of Newport Securities, a Costa Mesa brokerage firm. Oftentimes, the difference between what different dealers will sell a particular stock for are tremendous, so it pays to have a broker who will shop around.