Ponder this BEFORE Entering Deadwood

First the link:

http://www.usatoday.com/money/perfi/columnist/krantz/2005-04-29-pink-sheets_x.htm

Investor beware: Pink Sheets, Bulletin Board often too risky

Q: I have noticed you always tell investors to avoid investing in penny stocks and stocks trading on the Bulletin Board or Pink Sheets? When will you reconsider?
A: For whatever reason, the number of e-mails I've gotten regarding penny stocks of all sorts has spiked lately. I've heard it all. In e-mails that are almost cut-and-pasted out of the movie Boiler Room, I've been told that such-and-such stock that trades for 20 cents is the next Home Depot. Some have insisted that even Starbucks was a penny stock (which is not true). Yet others have said when companies get delisted from the Nasdaq to the Bulletin Board, that creates huge buying opportunities.

I'd first like to say that from this point on, with an occasional exception, I will not be answering questions about stocks traded on the Bulletin Board or Pink Sheets. Don't worry. We'll still have plenty to talk about, since there are thousands of stocks listed on the New York Stock Exchange, Nasdaq and American Stock Exchanges.

That's not to say that all stocks on the Bulletin Board or Pink Sheets are scams. There may be some OK stocks there. I'm just saying that the risks to investors are dramatically higher when dealing with these types of stocks.

But, since this is likely my last answer on the topic, I wanted to leave you with some of the reasons why a vast majority of investors should avoid penny stocks because they are:

• Common targets of manipulation and fraud.

And the opportunities for fraud come from both traders and companies. Since the share prices of these stocks are so low, often 30 cents or less, a single investor is able to buy or sell a large number of shares and have a big influence on the stock. Certainly, this can also happen with listed shares. But it's much easier for more investors to do this when share prices are low.

Then there's the opportunity for companies themselves to misrepresent themselves or manipulate the stock.

Don't want to take my word for it? The Securities and Exchange Commission has researched this topic exhaustively and made its findings available to the public. A few great links include:

http://sec.gov/investor/pubs/microcapstock.htm

http://sec.gov/answers/pink.htm

http://sec.gov/investor/pubs/avoidfraud.htm

• Fodder for online bulletin board and chat rooms.

Due to the ease that many Pink Sheet and Bulletin Board stocks can be manipulated, it's not surprising that many investors try to do just that on a variety of online forums.

Again, I understand that even massive companies are discussed on such rooms. But again, due to the smaller market values of penny stock companies, chatter and banter on such sites have a larger influence on them than with large companies like General Electric.

You don't have to take my word on this either. Below is what the SEC has to say on the topic:

http://sec.gov/investor/pubs/cyberfraud.htm

• Full of misconceptions.

Many penny stock investors like to say both Starbucks and Microsoft started out trading for less than $2 a share. That is simply not correct — and reflects the lack of knowledge many penny stock investors have.

Let's take Starbucks as an example. Some investors may look up the stock and say the shares got as low as $1.28 in June 1992. That's not the case, due to the influence of stock splits. In Starbucks' case, the stock has had four 2-for-1 splits since it debuted on the Nasdaq. That means that in June 1992, the stock price was actually $20.50. You can undo the affect of the stock splits by multiplying the amounts of the splits. In Starbucks' case: $1.281 x 2 x 2 x 2 x 2 = $20.50.

In addition, many investors like to get people excited about Bulletin Board and Pink Sheet stocks by saying they're about to get listed on a major exchange. That simply is hype, and rarely happens. Again, yes, it has happened. But it's a rare occurrence.

These are just a few of the reasons why a vast majority of investors are better off sticking with stocks on a major exchange. And I'm fully aware there will still be people who like investing in penny stocks. And they're entitled to their opinion. But for the smart money, it's better to avoid these stocks.

Matt Krantz is a financial markets reporter at USA TODAY. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com.