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November 9, 2005

Reader mail about micro-cap, Wed., Nov. 9, 2005, 11:25 AM

Edward wrote me an interesting letter. I first thought it was a Comment to the blog, and I immediately moved to strike the ticker symbol because I will not have this website become a tool of stock promoters and cheerleaders. Then I saw it was direct mail, so I quickly looked into the stock. I saw enough to the reader's question to want to use his chosen trade as a case in point with my answer.

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Bill, I purchased AOB 400 shares of AOB at $5.18 per share on 11/1/05. I purchased it because the balance sheet looked great but I didn't buy much because it is very small and risky.

The stock has just hit $7.00 per share for a 30% plus gain. I will watch this like a hawk because when the rocket fuel runs out, this could go into free fall.

My question is not about whether I should hold or sell.

Does a stock produce interest from institutions once it crosses the $5.00 mark? Is this stock rising due to institutions purchasing it as it crosses the $5.00 mark? /Edward"

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Here is the info on AOB from Hoovers, Yahoo Finance and ADVFN. I'll let readers make up their mind.

I like what I see, but there are only 40 million shares outstanding, and revenue and profits are quite small. It's a micro-cap stock and I'm not interested in writing about those here because I don't ever wish (again) to be perceived as a Dream Merchant.

To answer the question, I think financial institutions will invest according to their mandate, regardless of the apparent prospects for a particular stock. Very few fund managers have a mandate to invest in a company as small as American Oriental Bioengineering Inc, a company headquartered in Harbin China with a stock that recently began trading on the AMEX under the AOB ticker.

One problem is the lack of float. An institution must use prudence in that they must be able to sell a position if they subsequently discover reasons to sell. It is a fact they cannot afford to buy 1,000 shares or 10,000 shares of a $5 stock. Since AOB has just 40 million shares outstanding, including a float that is a small pct of that, if the fund managers were to buy 100,000 or a million shares, how would they possibly sell if a problem arose? In fact, they would end up permanently owning it, which is contrary to their mandate.

You indicate you consider AOB to be a risky" holding. What do you think the investment board of a fund manager would think?

Of course, I suppose there are some very small funds that have a mandate to take extreme risk, and to trade very small positions, but, really, these are like retail accounts to a broker-dealer.

Interestingly, I often found that professional managers of funds would take (relatively small) personal positions in stocks like AOB. Everybody is seeking the next great market play, and fund managers are no different.

I think the $5.00 price level you are referring to is merely a notional definition applied to a penny stock". To answer that one, is Lucent (NYSE: LU) a penny stock just because it's trading at $2.75, and has been under $5 since about mid-2002? I think not. There are many institutions invested in LU.

In fact if you look at the Key Stats for LU at Yahoo Finance, you will see that one-third of the total outstanding shares of LU are held by financial institutions.

I hope that answers your query.

Posted by Posted by Bill Cara on November 9, 2005 11:25:03 AM | Category: Micro-cap stocks

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