What are Pink Sheets Stocks?
Pink sheets are stocks that cannot be traded on exchanges like NYSE/NASDAQ, for which there might be multiple reasons – they don’t have enough capital to go public, or it does not make sense for them to go public over a small capital they intend to raise, or they took a strategic decision not to go public because of the scrutiny regulatory boards bring into them.
There is a big debate on whether they should be allowed, or not. In order to see how they affect investing, and economy in total, we shall go in detail to see what they are, how they work, and how they act.
How do they Work?
Pink sheets work on the same or similar principles as that of generic stocks. The core idea is that demand meets supply and prices alter themselves accordingly. The stock begins trading at a certain price and low demand or high supply move the prices in the downward direction in small ticks (ticks are the minimum amount a stock price can move). High demand and low supply push the prices in an upward direction. A transaction happens when ask price is equal to bid price. However, there are a few main differences between how regulated stocks and pink sheets act.
- They are unregulated and do not cover the guarantee of the government or the audits that go on for IPO based trading companies.
- The market for pink sheet stocks is small compared to that of the IPO based stock market.
- The transaction charges are pretty high compared to that of stock markets, especially because the demand and supply match is low and operational costs are high.
- There are no financial standards that are to be followed and the company does not have to disclose anything. Any disclosure remains an intended detail owner puts out.
- In general, delinquent, distressed, and bankrupt companies are the companies that are traded in pink sheets.
Example of Pink Sheet Stocks
For those who have watched the 2013 film “Wolf of Wall Street”, pink sheets will certainly not be a new term. From the days of 1980s pink sheets have changed on how they are being traded and how they are being costed. The transaction charges have gone down quite significantly from the past 20 years. With the rise of the internet, companies like OTC Markets created a platform where people could trade penny stocks. Before such companies existed, people would have to call up to brokers and see if they wanted to invest in any penny stocks.
OTCmarkets.com gives information about the stocks they trade. And they quote that they trade about 10,000 stocks and about 60% of them are a penny. In their website, they call penny stocks like penny stocks – which is a widely used term for them in the USA. So, giving examples and wasting time on them would be pointless because a small google search can reveal hundreds of examples, if not thousands.
So, instead of looking at them, let us look at a penny stock that explains to us how penny stocks can be useful. Tencent, a Chinese company is one of the world’s largest software companies and it is valued over 200 billion US dollars. But people who want to buy these stocks in the USA, have no chance to do so. The Chinese regulations over foreign investments are pretty stringent. So, companies like OTCmarkets go ahead and sell unsponsored ADRs of Tencent in the USA. The code for Tencent is TCEHY (OTCmarkets.com).
ADRs are American depository receipts and are essentially a way to buy stocks of an international company. Sponsored ADRs are bank bought ADRs which are formally traded and since banks don’t prefer to trade some companies, pink sheets provide a platform for them to raise more money if needed. And opening up to markets actually has a benefit of more information flows into the market.
Some of the advantages are as follows:
- These stocks provide an additional medium for trading. And the more the mediums of trading, the higher the number of people who keep trading. This increases the liquidity of the stocks and the true price of the stock can be easily realized.
- For companies, pink sheets provide a ‘no minimum requirement’ for either revenues or profits or the business they do. The companies need not show going concern or need not have to be in running condition for 3-4 years which is mandatory for companies to go public. Companies that are traded under this will not be audited as that of regular companies.
- There is no limit on the share price minimum or the number of shareholders. They are also governed by the fewer number of regulatory bodies and they don’t even require annual shareholder meeting or a formal set of board members. From a company’s perspective raising money through pink sheets is an absolute delight in terms of freedom they go when compared to going IPO.
- From an investor’s perspective, they are volatile. So, for those who are trying to trade, instead of invest in the long term, pink sheets might be a great option. They are available for less than one dollar and the ticker rate is one cent. So even a movement of one cent in the stock price varies the profits by a good percentage.
Some of the disadvantages are as follows:
- The benefits for companies are all trouble for investors. investing in a non-regulated, non-open companies can be a huge risk.
- The lesser amount of research will be available to invest in pink sheets.
- The SEC says that these stocks are a very risky investment.
- They are very volatile in nature, almost as volatile as option prices are.
- Sellers would have to be able to sell their shares at a very low price in case of emergency liquidation.
There is no debate that pink sheets are not regular investments. The debate is around whether they are to be allowed and the recent Sarbanes Oxley act of 2002 made it more difficult for companies to raise capital via this method. However, even today, it remains to be one of the easiest ways for companies to raise capital and they are the first step for many companies to go public. Many companies raise money via pink sheets, get going and then get into an official listing.
This has been a guide to what are pink sheets and its meaning. Here we discuss how do pink sheet stocks work along with an example, advantages, and disadvantages. You can learn more about corporate finance from the following articles –