Combine a "veteran newsletter writer" and his "top energy pick for 2008," and you have the kind of hype that can move a tiny stock. Chances are, however, that...
Combine a “veteran newsletter writer” and his “top energy pick for 2008,” and you have the kind of hype that can move a tiny stock.
Chances are, however, that you’ve also created a Stupid Investment of the Week.
That’s precisely what happened with Striker Oil & Gas, a Houston-based company that was the subject of a recent “complimentary report” (translation: junk-mail circular) for David L. Smith’s Cyclical Investing newsletter.
Since the piece started arriving in investor’s mailboxes during the second week of June, the stock has seen a big pop, and it now appears to have started the inevitable post-hype fallback.
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But unless someone was trying to play the hype, Striker was a bad idea when investors got the newsletter and learned of it, and it’s an even worse proposition today.
Stupid Investment of the Week highlights the concerns and characteristics that make a security less than ideal for the average consumer; it is written in the hope that showcasing trouble in one situation will make problems easy to uncover elsewhere.
Striker, an OTC Bulletin Board stock with a $6 million market value, buys oil and gas properties with an eye toward making them more productive through the use of “modern developmental techniques.”
Smith describes Striker in the flier as “my most undervalued energy stock in the market,” talks about revenue growth of 300 percent per year and says that “investors who act now could make a small fortune,” even if revenue growth slows in 2009 and 2010.
Given the appeal of energy stocks for the past few years, it’s a compelling story. But it’s also dangerously incomplete, simplistic and told by someone with a vested interest.
Before the Smith circular, no one could have said much of anything nice about Striker or Unicorp, Striker’s predecessor business. The stock lost 80 percent in 2005, dropped 37 percent of its remaining value in 2006 and lost more than three-quarters of what was left in 2007. The stock had experienced some rebound before the mailer, but doubled almost immediately after the special letter hit mailboxes. Year-to-date, the stock is up roughly 250 percent.
That’s good, but what it means is that during one of the biggest boom periods in history for oil, this energy stock has lost more than 90 percent of its value.
Striker executives did not return my calls for comment, but Smith says he thinks the company has turned a corner. The stock gets an “F” grade for profitability from investment researcher Morningstar, but Striker’s financial statements do show a first-quarter breakthrough. The firm posted a 2-cents-per-share profit during the first quarter; what’s not apparent until you dig into the numbers is that the company — which has a handful of employees — only has that profit because it stopped issuing stock options to employees, thereby reducing expenses.
Even if you take the quarterly profit at face value, an oil investor should recognize the obvious problem here: If a stock that amounts to a commodity bet on oil and natural gas can only pull down a 2-cent profit during a frothy time for the commodity market, it is likely to get hammered if the market for oil and gas takes so much as a sideways turn.
“There are still some good values in energy — I know that seems unlikely — but this isn’t one of them,” says John Buckingham of the Prudent Speculator newsletter. “On valuation alone, this has a much higher price-to-earnings ratio than bigger, better-established, more stable companies in the same business, so I wouldn’t touch it with a 10-foot pole. … And that’s before I worry about what the company spends for public relations.”
But the 24-page full-color public-relations effort is where the story gets interesting. Plenty of newsletters make deals where anonymous stock promoters pay for ad circulars, pumping newsletter subscriptions while moving a stock.
The Cyclical Investing deal is different, because everyone is in bed together on this.
The half-page disclaimer on page 13 of the mailer says the piece “is a solicitation for subscriptions,” and that the newsletter did not receive any compensation from Striker for writing it. The disclaimer continues: “Striker common stock was chosen to be profiled after Cyclical Investing completed limited due diligence on the stock. [The newsletter] expects to generate new subscriber revenue … through the distribution of the newsletter.”
It then goes on to note that Striker paid $595,127 to marketing vendors “to pay for all the costs of creating and distributing this report … in an effort to build investor awareness.”
That’s about one-eighth of the company’s projected revenues for the year. While Smith insists this is an ordinary investor-relations type of effort, well-established companies aren’t spending more than 10 percent of their incoming revenues for a temporary pop.
What’s more, Cyclical Investing did something similar for Unicorp — Striker’s predecessor — about two years ago, the only other time Smith says he has authorized a special mailer. Smith says that effort produced a quick up-and-down in the stock, and brought in just 75 new subscriptions, an amount he thinks the new effort won’t be able to muster.
Despite the lousy increase in subscriber revenues, Smith says he stands by his decision to allow his newsletter to be used in this fashion because he knows the Striker executives.
“I have been investing in this for a long time,” he says, “and I find that their industry prospects are interesting. I have a personal relationship with these folks and believe in what they are doing. … These people seem honorable, and they are expressing great optimism about this.”
That kind of “limited due diligence” may be enough for Smith, but it’s way too flimsy for anyone else — lacking that kind of insider connection — to follow, especially if they first heard about the investment via junk mail.
Says Buckingham: “Real companies don’t do this. They don’t spend so much of their money promoting themselves this way. That doesn’t mean they’re going to zero, but it means you have to take the whole story and really think if this is what you want to do with your money.”
Chuck Jaffe is senior columnist for MarketWatch. He does not own or hold short positions in any securities covered by Stupid Investment of the Week. If you have a suggestion for Chuck Jaffe’s Stupid Investment of the Week or a comment about this week’s column, you can reach him at firstname.lastname@example.org or Box 70, Cohasset, MA 02025-0070.