Houston American Energy Plunges
Shares of Houston American Energy Corp(NASDAQ: HUSA) took one heck of a hit yesterday. In fact, the stock plummeted 28.7% by the time the session ended, and I’ve got a feeling this is just the beginning of a story that will unfold in the coming days. We’ve been watching this stock here in Small Cap Investor Daily for a few months now, and shares had rallied 160% between February 1 and the close of Tuesday. And the trajectory was pretty much straight up. Even after yesterday’s drop, shares are still up 85% since February 1. And more than 700% over the last 52-weeks, a nice gain to be sure.
But like I said, this story is going to get more interesting. Yesterday afternoon PR Newswire released a statement that began with the following, “Houston American Energy… advised that the jump in trading volume appeared to be attributable to an internet posting questioning the valuation of the company's holdings and inferring that the company is "Set Up for Collapse."
Now, this is a big deal for several reasons, not the least of which is that the stock plummeted by nearly 30% (in case you’re wondering, I have no connection with that internet posting). This is extremely interesting because of the rapid rise in share price, the posting of information questioning the validity of the company’s valuation, the subsequent fall, and the fact that management had to come out and address the issue.
We don’t see this happen every day, where individuals acting completely independent of the company have this dramatic of an effect on the share price – that is at least, if you believe Houston American’s allegations that the ‘internet posting’ was actually responsible for the share price decline.
I’m not so sure, and I’m not going to jump to any conclusions right now. But I do know that something is amiss here, on one side or the other. I just don’t believe that this is an isolated event and everything is going to go back to normal today. So far shares have rebounded around 8%. Let’s keep watching...
***Earlier this week I responded to a question from Charles who asked how individuals with smaller amounts of money should get started in investing. I want to return to that question, and discuss how liquidity concerns affect small-cap investing. This is less of an issue if purchasing shares in large-cap companies because usually their shares are fairly liquid (easily bought and sold because large volumes of shares trade everyday). But some small-caps trade in light volume, so getting into and out of positions can be more challenging.
As I mentioned, liquidity refers to the ability of investors to get into and out of investments. Those stocks that have many shareholders and trade frequently with large share volume are considered liquid—it is easy to find a buyer or seller. Those stocks with few shareholders, infrequent trading, and low share volume are deemed illiquid.
Many small-cap stocks fall into the latter category, considered to be illiquid stocks. The reason is that the companies are smaller—meaning there are fewer shares issued, and likewise fewer shareholders including individual investors, institutions, and traders. This means that there are fewer people buying and selling shares of small caps compared with mid and large cap stocks. For example, Graham Corp. (AMEX: GHM), a small cap industrial company with a market cap of $189 million, has only 9.85 million shares outstanding. Google (NASDAQ: GOOG) on the other hand has a $178 billion market cap and 318 million shares outstanding.
It’s no surprise that with a larger number of shares outstanding and a larger market cap, Google has more frequent trading in its stock. Most financial web sites report a statistic called Average Share Volume, which represents the average number of shares traded every day over the trailing three months. Graham trades an average of 87,000 shares a day. Meanwhile, Google trades an average of 3.6 million shares a day. Clearly, it is easier to find a buyer or seller for Google than Graham, simply due to the higher share volume. Interestingly, Houston American trades at an average of 320,000 shares a day – but yesterday that volume surged to 4.5 million!
The greater share volume and liquidity makes for a more efficient market for buying and selling a stock. Small-cap stocks are often not anywhere as liquid as larger publicly traded stocks. As a result, it can be difficult to buy and sell shares at attractive prices, and the share price at times doesn’t represent the true value of the company.
On the other hand, an astute investor can watch a small-cap stock and take advantage of short-term market inefficiencies, buying shares when others have driven the price down. Of course, make sure you have done your due diligence before employing this technique. This characteristic of small cap stocks is one of the reasons mutual funds can’t establish big positions in them – otherwise they will drive the price above their desired entry price. I’ve discussed how this creates an advantage for the individual investor several times, so I won’t go into greater detail here today.
Due to the illiquidity of many small-cap stocks, the share prices also tend to be more volatile. This means that the share prices tend to rise and fall more rapidly, since the market is less efficient due to fewer shares trading hands and fewer investors buying and selling. Prices of many small caps move quickly on news or speculation, and can make buying and selling challenging – but also can present great opportunities.
I've recently published a book that will help new investors get started, and help them to find the best small-cap stocks. It's called "The Small-Cap Investor: Secrets to Winning Big with Small-Cap Stocks." I filled it with every tip and trick I know about investing in small-caps, and I think it's absolutely vital to anyone interested in the topic.
