New companies are sought out by many investors for the obvious reasons of buying in at the initial issuance price of their stock and watching the profits from their investment roll in when they rise. This sounds good at face value, but finding a new company to invest in presents some difficulties, and researching one can be equally difficult or even not possible.
New companies come in two flavors, private and public. Private companies are owned by private individuals and don't have to comply with the filing requirements of the Securities and Exchange Commission (SEC), which public companies must do. These companies may issue stock to company employees but they don't trade on the public exchanges. The only way to invest in these companies is by going to the owner and asking, but that doesn't mean that he'll sell anything. Most companies have web sites where some useful information can be found. Local business journals are another source.
The following publications can give you more ideas on researching private companies:
Researching Private Companies
Arlington, VA: Washington Researchers
LC Call Number: HD 2771.H695
Hoover's Handbook of Private Companies
Austin, TX: Hoover's Business Press, c1997
LC Call Number: HG4057.A28616
LC Control Number: 98657723
New Public Companies
Public companies have met the SEC requirements for disclosure of financial information and comply with its strict rules and regulations.
The first issuance of stock shares to the public by these companies is known as an initial public offering (IPO). This became a well known term during the 1990s. Many dot.com entrepreneurs became overnight millionaires when their Internet companies issued their IPOs on the stock market. Many of these companies collapsed, but some are still around.
The IPO is a very long process and the chances of small investors getting in on an IPO before it is issued are very low, as underwriters are looking for institutional clients with large amounts of money to offer IPO prices to.
What to Watch For
Some of the things to watch for when researching IPOs are:
- Initial prospectus issued by the underwriter. This contains much useful information.
- Lockup periods are agreements between the underwriters and the company insiders that prevent them from selling their shares of stock for a specified period of time that can last for a minimum of ninety days to two years. When this period ends many of the insiders want to sell their shares of stock which can significantly drive down the market price.
- A tracking stock is a spin-off of a department or division from another company in the form of an IPO. Basically, an investor would be buying the stock of a subsidiary without a claim to the assets of either the parent company or the subsidiary.
Another riskier place where new companies can be found is known as the over-the-counter market. These companies are usually too small to be listed on the exchanges and are traded through a dealer network with no central location.
Companies whose stocks are sold on the OTC are usually listed on the over-the-counter Bulletin Board (OTCBB), owned by Nasdaq, or on the pink sheets. The OTCBB is a quotation service that lists stocks that are penny stocks or have dubious credit histories. All of these companies are still required to be registered with the SEC.
Pink sheets refer to an OTC market that also connects brokers and dealers electronically and is owned by a company known as Pink OTC Markets, Inc. New companies get listed on the pink sheets by submitting a form 211 to the OTC Compliance Unit, which has their current financial information. These companies do not have to be registered with the SEC.
Some reasons that these stocks are considered risky are:
- Information is hard to find for the average investor. These companies aren't covered by analysts.
- They have a low amount of liquidity. Thinly traded stock shares are hard to sell without lowering the market price. Finding buyers can be difficult.
- Lack of minimum standards.
- Lack of history.
Pink Sheets Tier System
A pink sheet tier system was developed in an effort to give investors some indication of the risk involved with each of the companies that are listed on the pink sheets. The name of each tier pretty much speaks for itself:
- Trusted Tier – This tier consists of international and U.S. companies that are considered trustworthy. They all follow some kind of reporting standard or listing standards somewhere like the NYSE, SEC, or Nasdaq.
- Transparent Tier – These companies are lower than the Trusted Tier but still present current information (less than six months old) to the SEC or the OTC Disclosure and News Service.
- Distressed Tier – This tier has companies with mostly old or limited information available. Bankrupt companies appear here.
- Dark/Defunct Tier – Companies that basically haven't filed any information for at least the last six months or they have no market maker.
- Toxic Tier – What more can you say about a tier whose symbol is a skull-and-crossbones.
New companies are always entering the markets. The potential for profits is always there as well, but not without risks. As anyone can see, new companies can run the gamut from high to low risks on the formal exchanges and on the over-the-counter exchange. It's always helpful to know what to be looking for and how to be looking when considering them for an investment.
- John Devcic, "The Over-The-Counter Market: An Introduction To Pink sheets," Articles, 2010. Investopedia. Retrieved January 27, 2011 from the World Wide Web: http://www.investopedia.com/articles/fundamental-analysis/08/pink-sheets-ottcb.asp
Investopedia Staff, "The Murky Waters Of The IPO Market," Articles, 2000. Investopedia. Retrieved January 27, 2011 from the World Wide Web: http://www.investopedia.com/articles/00/100300.asp
Investopedia Staff, "A Look At The Primary And Secondary Markets," Articles, 2002. Investopedia. Retrieved January 27, 2011 from the World Wide Web: http://www.investopedia.com/articles/02/101102.asp
Seattle Securities Building Lobby, public domain, Wikimedia.
View From the Members Gallery, NYSE, public domain, Wikimedia.