The Thinly Traded Stocks of Small Companies Can Be Thick With Risk
Nick Giroffi thought he was getting in on the ground floor of a great investment opportunity about 20 years ago when he bought shares in a friend’s company, New York-based North American Enclosures. But what he really got was a lesson in the risks of buying into small companies that have few public shareholders.
For a few years, Giroffi received encouraging financial statements. Although earnings were still slim, sales of the company’s bathroom enclosures--mainly shower and bath stalls--were doubling and tripling each year, North American reported. Company managers were doing so well that they moved from Giroffi’s working-class neighborhood to Long Island’s pricey north shore.
When Giroffi received a letter saying the company was halting its practice of sending annual financial statements to shareholders because it was no longer required to report regularly, he passed it off as a savvy cost-cutting move. After all, the company was still young and needed to conserve cash to grow. (Securities rules exempt small companies that have few public shareholders from having to produce and mail regular financial statements.)
Besides, he could still get the company’s financial information by calling his broker, he figured. He ignored the change--and his investment--for several years.
The shock came when he tried to get a price for his holdings. The stock was no longer trading--anywhere. Brokers couldn’t get a price. The firm that originally sold him the North American shares was nowhere to be found. Company officials--his former friends--declined to return his calls, he said. They also did not return a reporter’s phone calls seeking comment.
Yet the company survives. All outward signs indicate it has grown substantially since Giroffi purchased his shares. But because he can neither glean the company’s earnings or assets nor get a price to trade his stock, Giroffi’s 300 shares of North American Enclosures languish.
Giroffi’s situation is unusual but not unique, says Harry K. Eisenberg, publisher of Lafayette, Calif.-based Walker’s Manual of Unlisted Stocks. While buying shares in small, thinly traded companies has an appeal--if you hit it right, you can double or triple your money in the blink of an eye--it also has a host of risks, he says. Not the least of those risks is just what happened to Giroffi--the company survives, but the shareholders suffer for lack of information and lack of a market for the company’s stock.
“If a company falls under 300 shareholders, they can elect not to file [financial information] with the SEC,” he adds. “They become almost quasi-public. They have shareholders, but they may not be interested in complying with any disclosures.”
Jack Norberg, president of Standard Investment Chartered Inc., a Tustin-based investment management and brokerage firm, makes his living investing in small firms. Because of similar problems, he’s been involved in roughly a dozen lawsuits seeking to compel disclosures and appraisals of what the company’s shares are worth.
In the scheme of things, Giroffi’s problem is easy to solve, he adds. New York securities regulators require companies to respond to shareholder requests for financial information within five business days, he notes. If the company doesn’t want to mail its annual report, it must make it available for viewing by shareholders. Giroffi can also ask for a list of other shareholders and contact those holders to see if they want to buy his stake, Norberg says.
“At this point, he has to work for his money,” Norberg says. “This is one of the occupational hazards of investing in the micro-cap market. You are open to self-serving decisions on the part of the board and management. You have to know how to fight them to protect your interests.”
Despite Giroffi’s tale of woe, Eisenberg and Norberg agree that tiny companies can be remarkable investments. Share prices in top-notch small firms can multiply in value in a single year, Eisenberg says. Moreover, when the market is down, these firms sometimes don’t get hit as hard, mainly because it’s hard to buy shares in the better small companies, he notes. There are few shares traded and the existing shareholders are reluctant to sell.
But you have to be careful about what you buy.
Of the 30,000-plus small companies that trade over the counter, about 10% are “very valuable, very good investments,” Norberg says. However, the vast majority are either lackluster performers, money losers or even shell companies that exist in name only, he says. Investors in this market need to be sophisticated enough to fully understand financial statements--and understand their rights as shareholders--to survive.
“The stocks that trade over the counter are for people who are willing to take a higher degree of risk for a higher potential return,” Eisenberg says. “But for a lot of people, it makes more sense to stick with the blue chips” (major companies such as General Electric Co. and IBM Corp., usually listed on the New York Stock Exchange).
Giroffi agrees. In retrospect, he thinks small stocks are not for small investors.
“You need quality stocks--big names,” he says. “Watch out for the little guys, because sometimes they are not all that they are cracked up to be.”
Times staff writer Kathy M. Kristof is a syndicated columnist. Write to her in care of Personal Finance, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail kathy.kristof@latimes.com.
