Editor’s note: This article was first published in October 2013; Service Point Solutions’ 58% fall and pre-insolvency risk, the day’s share price moves and the list of rebounding stocks reflect market conditions at that time, and these companies’ situation may have changed since. These October 2013 calls are kept as a historical record and are not investment advice. The four charts the article refers to could not be recovered.
Service Point Solutions (SPS) suffered a crushing fall on the stock market on Friday, losing 58% because of problems refinancing its debt, which could push it into pre-insolvency proceedings. The truth is that it came as a surprise both to those who follow the stock and to those who don’t, although a very timely one, since SPS had staged a dizzying rally over the previous few weeks.
After opening today with gains of more than 9%, it is now down nearly 4%, which makes SPS a very dangerous stock at this point.
What can we learn from what happened to Service Point Solutions?
SPS shows exactly what will keep happening with many other penny stocks. On the Spanish continuous market (Mercado Continuo) there are many companies whose shares are rising without the fundamentals to back them up. They are mere technical rebounds, driven by the hope that at some point these companies’ balance sheets will return to pre-crisis levels.
In other words, investing in penny stocks this way is like playing the lottery.
A few weeks ago we said that before investing in a small-cap company, we should check that, at the very least (to begin with), it has a meaningful volume of business, ideally a growing one. In the same way, at this stage debt matters, because many of these companies will have to refinance their debts, and if their volume of business is small, I doubt any bank will be willing to refinance them.
What I mean is that we will see what happened to SPS again with many other companies, and we will probably see some company disappear from the continuous market. So place your bets on which companies have staged strong technical rebounds while their balance sheets keep getting worse and their debt keeps piling up.
Second lesson.
The entry point is what matters most. I insist that you should not buy into these companies during strong rebounds. If you like SPS, you should have bought it at its lows, around 0.10 euros. That goes for all the companies that are rebounding on technicals, including our top recommendation, Ezentis, as well as Quabit, Urbas, Tavex…
Let’s not jump on moving trains. If we liked the train, we should have spotted it while it was standing at the station. That is the only way to limit the risks of investing in this kind of stock. If the opportunity gets away from us, we let it go and note the lesson for next time.
In short: we are looking for stocks with a growing volume of business and shrinking debt, regardless of what their chart looks like. Anything else increases the risk of investing in the next Pescanova (the Spanish fishing group that filed for insolvency in 2013).
Featured image: AverageLooby, CC BY-SA 4.0, via Wikimedia Commons.
