Friday, June 03, 2011

Anatomy of a Stock Crash: Stratton Holdings Inc., STHG

Trading penny stocks has turned some people's small fortunes into large ones - but more frequently done the exact opposite. That was something I witnessed yesterday, with the plummeting stock price of Stratton Holdings Inc. (STHG) in the pink sheets.

In a single day, STHG lost no less than 64% of its value - and took with it thousands upon thousands of dollars of people's money. Even by penny stock standards, it was a pretty appalling collapse; but did offer some valuable insight into the market that will ultimately prove more valuable than any cheap profit made from trading the company's stocks.

Dissecting the disaster highlights certain factors that nobody could have anticipated - but also identifies many warning signs that people should have heeded. For me, just starting to dip my toe into penny stocks, Stratton Holdings STHG rewarded me richly yesterday by giving me months worth of insight into how NOT to work the market.

The Collapse

Yesterday, Stratton Holdings Inc., STHG stood at the lofty heights of half a penny per stock, 0.005. If you look at the chart for the previous month, you'll see that this is quite a stratospheric improvement from where it had been sitting not just a few weeks earlier, but for the previous six months. In all that time, since the end of 2010, Stratton Holdings Inc., had struggled to get above a tenth of a penny per share.

Stratton Holdings Inc., STHG 6 month stock performance, courtesy of eTrade

This hike in the share price came from some pretty meaty volume in the two weeks leading up to yesterday's high of the year. Daily trades ranging from 50 million to 200 million shares helped lift the stock from where it had been languishing to five times its previous value.

Now this is where it got dangerous - because this kind of stock price movement was not atypical of Stratton Holdings Inc., STHG. If you look at their 3 year chart, you'll see that the stock price sits resolutely flat at about a tenth of penny for ten months out of the year, but has a periodic spike every now and again.

Yesterday many investors, myself included, looked very briefly at the history of STHG and its recent performance and assumed that the same thing was happening again.

Stratton Holdings Inc., STHG 63 year stock performance, courtesy of eTrade

Was it an entirely reasonable assumption to make? At the time I'd have said absolutely "yes" - and was not alone. STHG was the talk of Twitter and the penny stocks forums last night, with people urging everybody to get in on this stock while it was skyrocketing to the top.

But this is where due diligence pays off - and a little bit of a research would have shown that something screwy was going on.

If you go back to the stock-price spikes of 2009 and 2010, two things stand out - promotions. Both stock spikes coincided with Stratton Holdings Inc., actually doing stuff. At the end of 2009 they bought a few companies, including LymeCLR (which produces a treatment for Lyme disease) and in 2010 released a corporate update revealing their financial plans to new shareholders. Both events were met with the stratospheric spikes in the chart above.

But yesterday's hike to half a cent? Inexplicable.

In fact, if you followed the CEO of Stratton Holdings Inc., STHG you'd have seen that he was equally as baffled by the surge in stock price as anybody - and made it very clear that the uptick in price had nothing to do with anything STHG was deliberately doing to manipulate their share prices.

Eric Stratton Racheff is CEO of Stratton Holdings Inc., STHG and you can follow him at @strattonracheff on Twitter

If life was a play by Shakespeare (and who's to say it isn't?) reading this tweet would have been accompanied by the sound of thunder (and possibly your old drama teacher whispering: "Foreshadowing!")

Regardless, thousands of investors chose to ignore what Eric Racheff had to say (including myself) and bought into STHG yesterday thinking that the only direction it could go was up, baby!

And that's when it happened:

Stratton Holdings Inc., STHG 1 day stock performance, courtesy of Google Finance

After an initial morning spike in trading, the price went down harder than a fat girl off a showjumping pony. In mere hours, it crashed right back down to the depths STHG had been languishing at for the previous six months - and literally thousands of penny stock traders lost their shirt.

I was one of the lucky ones. I'm still only dabbling in stocks, so I had invested in less than a hundred thousand shares. Nevertheless, it was incredibly disheartening to see your 'sure thing' go south faster than an Air France flight. In the space of a few hours people went from rubbing their hands greedily together to banging their heads against their desks.

But this is where it gets interesting...

The Conspiracy

There are many reasons why wise investors should have steered well clear of Stratton Holdings Inc., STHG - but they shouldn't entirely blame themselves. One figure stands out that reveals something really screwy went on behind the scenes. Check out iHub's status for the day:

Stratton Holdings Inc., STHG stock performance, courtesy of iHub

The screwy figure is the volume - the number of shares traded. A whopping 650 million shares got dumped in a single day.

That's suspicious because in June of last year, Stratton Holdings Inc., issued a letter from CEO Eric Stratton Racheff confirming that the number of authorized shares was frozen at 795 million (and he confirmed that was still the case yesterday, via Twitter.)

Stratton Holdings Inc., STHG Board Resolution June 15, 2010

Eric Stratton Racheff confirming authorized shares are still frozen at 795 million. Follow him at @strattonracheff on Twitter

That means a full 83% of all Stratton Holdings Inc., STHG stock got dumped yesterday. That's what caused the astonishing crash in stock price. Yesterday morning, people were clamoring to get their hands on STHG shares and that made it easy for a few crooks to find buyers for stock that was clearly overpriced.

In short, somebody made out like a bandit - and the thousands that followed them got their fingers burned.

Since then, all sorts of conspiracy theories have been drawn up - including one which blames the whole debacle on a single Twitter character, WrongTurnStock, who the masses are now blaming for front-loading and pump-and-dumping the stock.

He's certainly an unlikeable fellow. He spent all of last week pushing Stratton Holdings Inc., STHG as a safe buy, even well into the evening before the crash. When the stock price plummeted, he wrote:

Follow him at @WrongTurnStock on Twitter

But as much as it would be nice to come up with a "bad guy" for what happened, I don't think it's him. This is just some guy giving stock tips on the Internet.

A "pump and dump" on the scale of Stratton Holdings Inc., STHG would have taken several hundred thousand dollars and a team of co-conspirators, which I frankly don't think this guy is capable of. If the crash was a conspiracy, it would have been completed by a few silent, shadowy figures hunched over a desktop - not some braggart who gloated about it afterward.

And, in this chap's defense, he was warning people not to get greedy even while the stock price continued to climb. This is the behavior he gets his eponymous "PIGS" catchphrase from:

Read from bottom to top - the response to the initial (complimentary) comment. Follow him at @WrongTurnStock on Twitter

If he'd really been involved, WrongTurnStock would have been telling him to "buy, buy" and hold onto what shares he had ready for the dump taking place just a few hours later.

Lessons Learned

No, sadly there isn't a bad guy who can easily be identified here. If anybody's to blame, it's us. Far too many people, myself included, got onto the STHG bandwagon thinking that the only way was up, when every indication actually suggested otherwise.

It's been a valuable lesson on how not to pick a stock; although few investors probably feel they can afford lessons if they come at this price.

For me, there were some tangible and intangible things I learned about picking and choosing stocks to invest in. Fortunately, in the big picture, I'm still up 100% in my stock portfolio - and that success is based on a few factors I ignored when I invested in STHG:

Here's where I went wrong:

Stratton Holdings Inc., STHG
is a "holdings company." It doesn't do anything. Every successful investment I've had previously has been with a company that services or produces something, which means it has the potential to be profitable outside of simply raising equity. This is an old philosophy of Warren Buffett that I stupidly ignored.

Stratton Holdings Inc., STHG had miserable financials. Check out these figures, which were from STHG's financial report released in April:
  • $96,801 total assets
  • $161,600 total short-term liabilities
  • $346 sales revenue
  • $14,106 net loss
Yes, you read that right. They had a total sales revenue of $346 dollars! Whichever way you carve it, that's a warning sign not to touch their shares with a barge pole.

Stratton Holdings Inc., STHG was clearly overvalued when I (and thousands of investors) bought into it. Even the CEO himself thought so! Using my very unscientific method of calculating stock prices I figure the value of STHG shares is actually 0.0012. If only I'd bothered to work that out before I bought into it!

Stratton Holdings Inc., STHG had no news, no press releases and no developments that might have given their share prices a boost. Again, this is something the CEO himself acknowledges. A few minutes of additional homework would have warned thousands of investors that the spike in stock price was at best inexplicable, and at worst the cynical manipulation by some powerful shareholders.

Right now, I'm torn between kicking myself for being such an idiot - and patting myself on the back for being able to objectively take away so much information from this stock dive. For the few hundred bucks it cost me, I think I've gained a lot of knowledge about how to approach buying stocks in the future. Any loss I made will, I anticipate, be made up for many times over through the lessons I've learned.

But what now for STHG?

I, like thousands of other shareholders, are now left "holding the bag" when it comes to STHG. We're sitting on millions of stocks that are finally back where they started at - arguably a fair price for them, but dramatically less than what we paid.

There's no quick fix. Stock forums and investment websites are pleading for a "bounce" to bring stock prices back to what they had been when people bought into them. That won't happen - not as long as Stratton Holdings Inc., STHG continues to operate as it has been doing for the last six months.

And that's the real lesson we all should have considered before we bought into this lame duck. Sadly, we were blinded by greed instead. We should have all seen the writing on the wall, but instead we just saw dollar signs. As far as I'm concerned, that's given me all the "value" for my investment I could have asked for - perspective.

The rest of the shirtless investors, however, will have to make do with the recent promise of CEO Eric Stratton Racheff. He promised big things were on the horizon for Stratton Holdings Inc., STHG.

Follow him at @strattonracheff on Twitter

I'm not sure if I entirely believe him - but I've got just enough faith to hold onto my shares and see how this "exciting stuff" plays out. Maybe - just maybe - we'll be rewarded for our patience instead of punished for our greed.

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