Why everyone loves penny dreadful stocks

Penny dreadfuls – stocks that sell for a handful of cents yet give big percentage gains – have a long history in Australia. Since the beginnings of the stock exchange, resources explorers have traditionally filled this role, often hitting paydirt with a drilling hole, resulting in a share price surge.

More recently, technology stocks and biotechnology stocks – where successful clinical results can have the same effect as a bountiful drilling hole – have also surged on perceived “blue sky”. But old habits die hard, and Australia’s legion of stockmarket speculators love to trawl the lists of exploration companies.

“Traditionally resources explorers is where people have looked for that ‘ten-bagger’ (a stock that delivers a capital gain of ten times its purchase price),” says Gavin Wendt, senior resources analyst at Fat Prophets. “The prime catalyst for sending a resources penny-dreadful soaring is exploration success. There’s a big correlation between good exploration results and big share price increases on high volumes.”

In particular, the names of nickel explorers Poseidon and Tasminex live on as exemplars of instant riches – and the inevitable bust. On one day in January 1970, Tasminex shares surged from $3 to $96 on the basis of a false report that the company had struck nickel at Mt Venn in Western Australia. In those heady days, even that jump was made to look paltry by fellow nickel explorer Poseidon, which rocketed from 50 cents to $280 in a few months, on news that it had struck nickel nearby at Windarra.

In November 2001, explorer Minotaur Resources released drilling results from its Mt Woods joint venture in outback South Australia, showing a massive copper intersection at the Prominent Hill prospect, and triggering a tenfold surge in its share price. The news set off a chain reaction, of punters jumping into any stock that owned exploration ground in a radius of several hundred kilometres.

More recently, in the uranium boom of 2005-2006, internet-security-firm-turned-minerals explorer Fast Scout (now known as Strike Resources) rocketed 1800 per cent – from 1.1 cents to 20 cents – in two days in September 2005, after entering an agreement to buy a stake in some uranium exploration tenements.

(Strike no longer has uranium tenements – it has iron ore, gold and copper prospects in Australia, Peru and Indonesia – but if you were fortunate enough to have owned Fast Scout shares at 1.1 cents, they’re now worth the equivalent of 54.2 cents, after a one-for-three conversion in January 2006. And it still has not mined a gram of anything!)

Fellow explorer Cudeco soared from 2.5 cents in July 2005 to $10 (intra-day) a year later, on the back of spectacular drilling results from the company’s Rocklands copper project in Queensland. The stock now trades at $3.05.

But it isn’t only resources explorers that can be sent to the stratosphere. At the height of the technology boom of 1999-2000, SecureNet, a global provider of secure e-commerce applications – one of the Australian exchange’s tech darlings at the time – surged from around 20 cents in 1998 to reach $19.90 a share in March 2000.

In the same month, cellular neuroscience software and equipment maker Axon Instruments ballooned 11.5 times in its first three days of trading, from 20 cents to $2.29. It is history that SecureNet was eventually bought by a US company is 2003 for $1.57 a share, while Axon was also taken over by a US firm, a year later, at 39 cents.

But the traditional home of blue-sky speculation remains the resources sector.

Wendt says the best sector for penny-dreadful surges changes all the time. “It’s gone in waves. Uranium has probably had its day in terms of the speculative market, for the time being. The most recent commodity would have been iron ore. The whole cycle started off four or five years ago with nickel, with that very strong movement in the nickel price that had everybody clamouring for nickel exposure.

“All it takes is one good drilling intercept to send a share price surging. If you’re punting for that sort of thing, both the risks and the rewards are potentially very large. The risks are that the exploration results are not followed-up by a series of results that starts to identify a resource, and then proceeds to establish a reserve. If that progress is not made, the shares can fall back very quickly.”

Tracking down the best potential penny-dreadfuls used to be a question of whom you knew – and what they knew. But with the move of the sharemarket away from physical crowds of gossiping brokers to screen trading – not to mention the codification in Section 1002G of the Corporations Law of the insider-trading laws – the activity of ‘spruiking’ stocks has moved online, to the “chat forums“.

“The Internet chat sites can really get this process going – the HotCoppers and so on – that helps to spread rumours about companies. That’s where you find the day-traders, people who are often trading on momentum (the rate of price change) and who aren’t really interested in what companies are actually involved in. They’re looking for el cheapo companies, sub-10-cent level, where small movements – a cent or two – can deliver a handy profit to a day trader,” he says. Between 0.1-9.9 cents in price, a stock can move by a minimum of 0.1 cents in price. Between 10 cents and 199.9 cents, the minimum ‘tick’ is 0.5 cents.

“At the moment, iron ore seems to be the latest thing that has its name running hot on the chat sites,” says Wendt. “Just go and look at Hot Copper and see what stocks are the most talked-about on any day. You’ll usually see something like CityView, which seems to be looking for every mineral commodity you can name in Africa, and Mindax, which is looking for everything you can name in Australia.”

On a visit to Hot Copper earlier this week, the five most-discussed stocks were:

– Minemakers (MAK)

– Retail Star (RSL)

– Golden West Resources (GWR)

– Cudeco (CDU)

– Mindax (MDX)

The fans of these stocks – and for many of chat-room denizens, that is the word – are hoping that their favourite stocks make the big money in 2008. Something like the performance achieved by the stocks in the table below would do the trick – if they’re not deterred by the fact that the stockmarket is a much less optimistic place today than it was then.

The 20 best-performed stocks of 2007