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OTC Stocks vs Exchange Listed Issues, Big Boards

17 May OTC Stocks vs Exchange Listed Issues, Big Boards

OTC Stocks vs Exchange Listed Issues, Big Boards

Some investors have only exchange-listed issues in their portfolios; no doubt many of them still use full-service brokerages.  That's how their parents did it.  But more and more people looking to the markets to supplement income and save for retirement have shifted their focus to over-the-counter stocks as a quicker way—they hope—to build a nest egg.  There are advantages and disadvantages to dealing in both kinds of stocks.  Of course, one need not make a hard and fast choice:  it's possible to keep core long term positions in exchange-listed issues while having fun with the pennies.

The exchanges

There are three major stock exchanges in the U.S., and a few smaller ones.  The big three are the NYSE, NASDAQ, and the AMEX, with the AMEX (now owned by the NYSE) lagging a distant third.  There were once a number of regional markets as well, but most have been eliminated by industry consolidation over the last decade or so.  The Philadelphia Exchange is now owed by NASDAQ; it was the nation's first stock exchange, founded in 1790.  The Pacific Exchange was sold to Archipelago Holdings, and now, following the acquisition of ARCA by the NYSE, is operated by the latter.  The old Cincinnati Exchange is now the National Stock Exchange, and is owned by the Chicago Board Options Exchange (CBOE).  The Chicago Stock Exchange (CHX) is still independent.  There is also the BATS Global Markets, which runs two exchanges from its headquarters in Kansas.  While it executes an impressive number of trades daily, in recent years it's been plagued by problems ranging from a failed IPO to disastrous technical glitches.  Other exchanges, like the CBOE and the Chicago Mercantile Exchange (CME) are dedicated to derivatives and options.

The NYSE and the NASDAQ are what most people think of when they think of stock exchanges and “big board” stocks.  Before the advent of the internet and discount brokerages, they were where most retail investors traded, to the extent that they “traded” at all.  Nearly all these people actually invested, buying stocks for dividends paid, or for long term growth.  In the aftermath of the Crash of 1929, heartstopping drama and wild volatility, at least of the good kind, were not prominent features of our capital markets, and nearly everyone was satisfied with that. 

Big board stocks

NYSE and NASDAQ stocks are still for the most part for real investors who want to buy and hold.  Dividends paid by blue chips are generally thought to be unattractively low.  In recent years only mortgage REITs (“mREITs”) have offered really substantial divvies—in some cases as high as 19%--but of late even they've been declining.  Growth stocks often grow slowly, or in fits and starts.

Big board companies, like any companies, can collapse and die for various reasons, causing shareholders enormous losses.  Smith Corona, once a highly successful manufacturer of typewriters and calculators, and Polaroid, once famous as the inventor of camera film that developed before users' eyes, failed to adapt to newer technologies and disappeared from the public markets.  Enron and others were destroyed by their own malfeasance. 

NYSE and NASDAQ stocks aren't known for doubling, tripling or more overnight.  But that doesn't mean they can't be moneymakers.  Had you invested $2000 in Microsoft at the time of its IPO in 1987, your stock would be worth $922,032 today.  That's in large part because MSFT did nine forward splits between 1987 and 2003; most of those splits doubled the amount of stock shareholders owned.  The price, of course, dropped proportionately each time, but because forward splits are considered to be positive for rapidly growing companies, it recovered quickly.  A nice investment, all things considered. 

Many would, no doubt, consider it a ringing endorsement of the buy and hold strategy.  It should be noted, however, that MSFT reached its historic high in late 1999, just before its price was sacked by the dot.com crash.  Since then, its performance has been far less spectacular than it was in the early years.

Microsoft has always been a fairly expensive stock; it IPO'd at $21.  The same is true for most NASDAQ and NYSE issues, though some cheapies have been available since the economic crisis of 2008.  Still, the exchanges have minimum bid prices for listing and for continued listing.  Historically, NASDAQ's minimum bid price for initial listing has been $4, but in 2012 that was lowered to $3 or $2 for companies that met certain additional requirements.  The minimum bid for continued listing is $1; the same is true for the NYSE.  Any stock whose price falls below that level and stays there for more than 30 days will stand a good chance of being delisted, which will only damage it further.

In short, the exchanges usually don't offer much in the way of thrills.  They do—with some notable exceptions—offer solid stocks that may appreciate over time. 

The OTC markets

Over-the-counters stocks do not, by definition, trade on exchanges.  Nowadays, they trade almost exclusively on OTCMarkets' electronic platform.  They're known to most as penny stocks, though some ADRs and regional bank issues can be quite expensive.

Most are cheap, though, and therein lies the charm they hold for many.  Their low price makes large percentage gains possible.  Exchange-listed stocks seldom run 300-500% in the space of a few days; with pennies, that can and does happen frequently, especially with issues that start out below 10 cents.  On the other hand, exchange-listed stocks rarely lose 50-80% of their value over a few tradings sessions; pennies can and very frequently do. 

That is why extreme caution is advised:  anyone who tries to buy at the absolute lows and sell at the absolute highs is headed for disaster.  Many NASDAQ stocks, among them the most successful and popular, have no liquidity problems.  They trade consistent, reasonably high dollar volume.  Penny novices often believe that trading volume equals liquidity.  It does not.  Only heavily promoted pennies are truly liquid, sometimes trading tens of millions of dollars a day.  But as the promo nears its end, the liquidity will dry up, often abruptly.  Anyone with a large position to unload may find himself out of luck.

Generally speaking, penny stocks are OTC because they have no money, no significant assets, and don't qualify for quality financing.  Though they're often touted as future industry leaders, they are not.  Only a few make it to an exchange—usually the AMEX—each year, and not many of them do well at their new venue.  While there are exceptions to that rule, they are few.  People who don't understand how to read split-adjusted charts like to say that many major tech stocks—MSFT, AAPL and more—started out as pennies.  That didn't happen.  They all IPO'd, most at prices above $20.  The only wildly successful NYSE-listed company I know of that really did begin its public life as an OTC issue is Walmart, a very long time ago.

Put bluntly, most penny stock companies are bad companies.  Some are outright scams; others are simply run by incompetents who've realized it's easier simply to sell stock than to build a business.  Don't be fooled by excited CEOs or even more excited promoters.  They're making most of it up. 

How can one be sure of that?  By doing research.  Exchange-listed issuers must file financial and other reports with the SEC.  While that doesn't mean fraud can be ruled out—Jay Knabb, CEO of Pegasus Wireless, which was briefly and embarrassingly listed on the NASDAQ, is now doing 17 years in a Federal penitentiary—it does mean potential investors can assess the company's past and present accomplishments.  Detailed filings are a starting point for due diligence.  Stocks trading on OTCMarkets' QX and QB tiers are also SEC filers, but Pinks are held to lower disclosure standards.  And since OTCMarkets isn't a securities regulator, not much is likely to happen to them if they fail to disclose material information, or are caught in a lie of omission or commission.

Many people find penny stocks attractive.  The smart ones enjoy successive flings, moving on with a profit after each.  Don't buy that ring:  diamonds have very low resale value.

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