How to Find (and Avoid) Stocks Headed to Zero
Editor's note: The world of microcaps is the "Wild West" for investors today...
And Altimetry founder Joel Litman is the sheriff who wants to help protect them.
In today's Masters Series essay, Joel shows just how dangerous these stocks can be... and proves why you need him on your side...
How to Find (and Avoid) Stocks Headed to Zero
Back in 2014, I got a strange phone call.
On the other end of the line, a law firm was asking me to investigate a tiny Chinese company for fraud.
The law firm believed the company – China Recycling Energy (CREG) – was misleading investors, and they wanted me to prove it.
You see, the U.S. Securities and Exchange Commission ("SEC") has a Whistleblower Program that awards millions of dollars for tips on fraudulent companies.
As a forensic accountant who teaches this stuff to the FBI... and as a member of the Association of Certified Fraud Examiners, the American Accounting Association, and as chairman of the Advisory Council for Uniform Accounting... they felt there wasn't anyone who could uncover the potential for securities fraud better than my team and me.
So we rolled up our sleeves. And what we found shocked us...
Early in our work, we found something unusual in the company's financial statements.
It wasn't the numbers that bothered us... it was the people behind the numbers.
The problem was in the auditing firm. You see, every company is legally required to hire an auditing firm to essentially check their numbers.
But China Recycling Energy had deliberately hired auditors who had a history of not doing their job. In other words, you couldn't trust the company's numbers, regardless of how good or bad the numbers looked. (It's no coincidence that China Recycling Energy had gone through three CFOs over the previous five years.)
The sad reality is, as I explained in yesterday's Masters Series essay, the SEC doesn't have nearly enough manpower to catch every company that tries this maneuver – especially microcap companies.
So the SEC had no idea the firm had hired bad auditors and therefore could have been reporting bad numbers.
The auditor was in violation of several rules that the Public Company Accounting Oversight Board ("PCAOB") – the auditor of auditors – reviews to make sure an auditor is doing its job. But the SEC wasn't paying attention.
Because I'm a former auditor, and because my team has seasoned fraud analysts, we don't just look at the numbers... we look at the people behind the numbers.
And that's how we exposed China Recycling Energy. Here's what the stock has done since then...
Within a month, the stock was down 40%. Two years later, the stock had fallen 90%.
Most people would have assumed China Recycling Energy was reporting legitimate numbers. But by digging through the financial statements, we found so much dirt on the auditor that we knew not to touch the company with a 10-foot pole.
The law firm that had hired me was overjoyed. In fact, over the following months, it asked us to investigate more companies...
On July 21, 2016, during the heart of the bull market, we locked in on six tiny stocks that had a variety of red flags, including reporting bad numbers, making eyebrow-raising acquisitions, and being a bankruptcy risk.
The large-cap S&P 500 Index is up around 50% since then, but this group of lousy stocks is down 27%...
In one form or another, these companies were all misleading investors. We found that many were essentially fudging their financials to make their numbers look a lot better than they really were.
Again, the problem is the source of the numbers themselves. As Harry Markopolos, who uncovered the Bernie Madoff fraud scheme more than a decade before it went public said...
They trust the accounting firms, which you should never trust because they're incompetent, on a best day they're incompetent, on a bad day they're crooked.
As a result, most people have no reliable way of knowing which stocks have the highest potential and which are worthless... especially in microcap land, where fewer people are calling out the bad players.
Our analysis has been so accurate, the FBI, law firms, and some of the biggest hedge funds in the world have invited us to their headquarters to show them how we do this.
That analysis is worth doing, but because the high-upside world of microcaps comes with a lot of risk, most people are too scared to invest in them. That's a shame, because high-quality microcap stocks can have incredible upside.
Not only does my team use forensic accounting to avoid troublesome management teams, auditors, and companies... we also use it to filter out the "noise" in these companies' numbers to identify exactly which microcap stocks have the potential to generate quick 300%... 500%... even 1,000% returns.
Regards,
Joel Litman
Editor's note: Joel believes that microcap stocks present the biggest moneymaking opportunity over the next decade. That's why he recently sat down on camera to detail exactly how he can safely guide you through these stocks. Already, he has found seven microcap stocks with legitimate 1,000% upside. Get all the details right here.