Editor's Note: This is the first of a two-part series on "below-the-radar-screen" stocks. Next up: Penny stocks.
Most investors have heard the term "pink sheets" as a reference to stocks. But how many know what they are.
Pink sheets are companies that are traded over-the-counter and that aren't part of any major stock exchange. But that doesn't mean they are any less valuable than traditional stocks, exchange-traded funds (ETFs) or mutual funds.
In fact, expanding your portfolio with pink sheet companies can be extremely lucrative, but you have to make the right moves to rake in the big profits.
Let me explain…
Pink Sheet Basics
Pink sheets began as listings on an electronic database provided by Pink Sheets LLC, and are so called because the quotes were originally printed on pink sheets of paper.
Companies that are involved in this kind of over-the-counter trading fall just outside of the many regulations that restrict the activities of the major stock exchanges. That means they don't adhere to many of the time-consuming accounting and finance regulations of the U.S. Securities and Exchange Commission or the National Association of Securities Dealers (NASD), which helps the companies run more efficiently.
Also, some companies list in the pink sheets as a first step to getting listed on a bigger exchange. And that alone can result in some price appreciation, as it may attract buyers that were previously wary.
However, first be advised that a transparency can also leave investors in the dark. These companies do not have to disclose as much about their business, and there is no one knocking on their door asking to see their figures.
Of course, that does not mean they are something to be completely avoided. The fact that companies in the pink sheets are not regulated by any major institutions can be nerve-racking to some, but it is overly cautious to think of this kind of trading as the "Wild Wild West" of the financial world. Keep in mind that fraudulent misrepresentation of financials is a Federal offense.
Also, in the past year, Pink Sheets LLC created a new classification system to help investors assess the legitimacy of the companies in their roster. These classifications range from the highest, "PremierOX" – which are priced at least $1 per share and meet the requirements of the major exchanges – to the lowest, "Caveat Emptor" (literally "let the buyer beware" in Latin). The complete hierarchy can be foundat the Pink Sheets Web site.
The problem with these stocks is simply that they are not badgered by any institutions to provide financial data on a regular basis. Instead, a wise investor who knows not to jump into shallow waters headfirst must approach them.
Despite not being obligated to, some of these companies still offer limited information on the Pink Sheets Web site. This information can be very useful to draw on as you research companies you're interested in.
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The next step is to request information directly from any company you might be interested in buying. Whether by phone or email, get in touch with the company and find out any information they can send you, whether it be about their finances, their products or even the state they believe their nation to be in (as many of these companies are overseas). Risk assessments, future opportunities – anything you need to know to be sure of a company's potential.
As a side note, some of these companies may not be very forthcoming with their information, and have even been reported to be hostile with researchers. Be wary of companies that will not consider treating the interests of their minority shareholders as their own.
Buy and Hold
Once you have thoroughly researched your stock of choice and purchased it through your broker or online, be prepared to treat it as a long-term investment. Because these stocks are smaller companies and are not constantly watched by analysts and regulators, they can sometimes go days without even a single share changing hands.
This will no doubt make some of the nail-biters out there anxious, because they won't be able to check their favorite stock at every smoke break, but most intelligent investors find it liberating to be able to ignore the roller-coaster ride that is the short-term market and focus on growth potential over the course of a company's natural life.
Now that we've given you the know-how to get started with pink sheet stocks, take the time to explore and research them carefully before you buy. And make sure you're prepared before you decide on a purchase.