Book Review:

Outsider's Guide to Speculative Stocks:
by Chris Bunka

"Most speculative companies will never be successful."

- Chris Bunka

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The above quote from Chris Bunka's recent book, The Outsider's Guide to Speculative Stocks, captures the essence of the difference between value investing and speculative investing. The kinds of stocks involved are two completely different kind of animals. The factors to consider in the former - earnings, sales, growth, debt levels, and so on, are not the factors you want to focus on in the latter. The popular strategy of buy and hold works well with the former, but will guarantee that you lose your shirt with the latter.

But people are still interested in speculative investments. Why? Because speculatives offer something blue chips can't - rapid price growth and huge gains. Blue chips are steady as she goes, reliable, dependable investments. They are the turtle in the story of the Hare and the Tortoise. They plod steadily onward and often win the race. But the zippy hare may make it to the quarter turn way ahead of the tortoise, and then poop out and fall asleep, just like speculative stocks. The hare is a short term bet. The tortoise a long term one.

And to successfully bet on the hare, you have to be prepared to bail out at an appropriate point. Like when you see the hare pull off to the side of the road to take a nap. And of course, you have to pick a good hare in the first place. Some of them may just be pointed in the wrong direction from the get go.

Most people do not really have a clue what they're doing when they buy a speculative stock. They participate in an activity value investor John Price calls anti-investing. They buy on the basis of a tip by their doctor, their next door neighbour or their auntie! But while Price promotes knowledgable value based investing, Bunka shows that one can invest in speculative stocks knowlegably as well.

Chris Bunka's Guide explains the ins and outs of speculative stocks brilliantly. It helps you understand the nature of these stocks, their cycles, what moves them up and drags them back down, and how they are handled by brokers, professional traders and company directors - the insiders. (Bunka is not talking about insider trading here, but about the professional investment community.)

The key to successful speculative investment, says Bunka, is to understand that your investment should be based on getting an answer to a specific question. For example, you may decide to invest in a certain gold mining company that is conducting some exploratory drilling somewhere and is expecting results soon. The question asked is "Is there gold in them thar hills?" The answer will determine whether the stock price moves or not. When a question is posed about a speculative stock, it is called a story.

As the date for results to be released draws closer, the stock may already be moving higher in anticipation of a positive result. When the answer is on the table - yes there is gold - then the stock moves higher still. In fact, hype and momentum can carry it quite high, before reality sets in and a new question arises - "Can the company get the financing to start mining the gold?" Often the results end up disappointing and the stock drifts back down again.

The Life-Span of a Speculative Stock

Bunka goes on to discuss what he calls "the most important component of speculative investing", cycles. Speculative companies have what Bunka calls life-spans and frequently more than one of them. Here is a short account of a life-span of a typical mining company as described in the book. Although it is easy to dismiss Bunka as a cynic from this account, I think it reflects a knowledgable assessment of what really goes on.

A company starts with an idea. It takes about a year from that point to get the company up and running. During that time the "directors and other insiders issue themselves 5 million shares of seed stock at $0.01 per share" The management also develops a plan to acquire properties, conduct research and so on. And they start to sell an additional three million shares "to friends and close associates who are willing to spend $0.15 per share in order to get a closer look at the company." Along with the $50,000 invested by the directors,this brings the company treasury up to $455,000.

The stock is now listed and "since virtually all of the shareholders are of the same mind, it is easy to move it to $0.50." Over the next six months "the story is peddled by brokers whose companies are taking part in this public financling." Another two million shares are sold at $0.50 raising a further $1 million.. Costs and commissions over the previous 18 months have eaten up the original $455,000 leaving the company with 10 million shares issued and $1 million in the bank.

Now the first geophysical results come in and "Surprise! Surprise! Anomalies are discovered that warrant further investigation." The company spends its money on drilling and six months later "results start to trickle in." Disappointing results cause the stock to pull back but "just in the nick of time, the final two holes produce very good results that have investors foaming at the mouth."

As the stock starts climbing towards $2.00, the insiders sell half their stock. The company issues another three million shares at $1.50 and "outsiders leap at the chance to participate in this momentous story and lap up the new stock."

Then, as "investors realize that it will be six months before the story can be spruced up again in the next drilling season, a slow, aimless decline begins."

Six months later, with additional properties and drilling programs under its belt, "the drama repeats itself" and the stock, which had settled to under a dollar, starts to move up again. The stock climbs back to its former highs, but drilling results are "inconclusive" and "insiders take the hint and sell the rest of their stock." When the disappointing final results come in, the outsiders are left holding the bag.

The story gets worse, says Bunka, as the insiders now have no stock themselves and thus, "no interest in doing anything constructive with the company. Only if and when the stock finally declines back to around twenty cents are they interested in creating a new story."

Although the details may vary, this is the basic life cycle of a speculative stock. Not for nothing Bunka calls his book an outsider's guide. It is of key importance for outsiders "to locate where the stock is in the life span cycle before even thinking about investing in it."

Road Kill & Other Tasty Treats

Bunka covers a wide variety of other topics in this entertaining book. A chapter is devoted to technical analysis, including such concepts as resistance, different kinds of market tops, Elliott Wave theory and Fibonacci numbers. Another looks at the timeliness of information and the boon to investors that the Internet and modern electronic communications brings. He writes about investor psychology and the importance of not getting emotionally attached to your stocks.

The last two chapters cover how to buy and how to sell a stock. This isn't just a case of calling up your broker. It includes such concepts as evaluating a company's management, thinking independently of the crowd, determining whether insiders hold positions in the stock and how much, diversifying. and understanding the cyclical nature of such markets as the Vancouver Stock Exchange.

He discusses the concept of "five deep bid and ask", which means looking beyond the bid-ask spread and seeing what other orders follow them in the queue. For example, if the current price of a stock is 42 cents but the fifth ask order is at $1.30, it shows that there are so few sellers that any strong interest will drive the price up.

An interesting concept that Bunka introduces while discussing cycles is that of "Road Kill", a term he coined. Road Kill is a stock that has been through a life span cycle but for one reason or another, the insiders were unable to or failed to sell their holdings before the stock declined. Now you have a stock trading at low prices with an ownership that is motivated to create another story.

Sometimes this story takes the form of a reverse takeover. The company is now a shell, but another private company that wants to go public takes it over, thus becoming a publicly traded company without going through a lot of hoops. The company may consolidate shares in such an action, and may change the name of the company as well.

A few weeks ago I wrote about a penny stock I got involved in called MIS International. I bought it without understanding what I was doing and watched it decline to mere pennies before rebounding in new garb to make me a handsome profit. After reading Bunka I understand exactly what happened. The question, "Will the company achieve the financing necessary to carry out its ambitious expansion plans?" came out negative. The company nosedived. But insiders did not bail out in time and were stuck with a large block of shares. They cast about for a new play and found one in becoming an Internet company, achieved through a partial reverse takeover. The stock soared.

Chris Bunka is a knowledgable writer on a tough topic. His Outsider's Overture newsletter is one of the fastest growing speculative stock newsletters around. And this book is a valuable guide if you have any interest in playing this market.

The book, unfortunately, is not available through Amazon.com or I would make it available here. You can get a copy by emailing Chris at outsider@istar.ca or writing the publisher:

Indpendent Outsider, Inc.
3930 Meridian Street, Suite C148,
Bellingham, Washington 98226

This quality paperback retails for $29 US. Although his publishing company is based in the U.S., Chris writes almost exclusively about Canadian stocks, particularly those listed on the VSE.

Selected Related Links

Insider Trading and Regulators - an excerpt from The Outsider's Guide to Speculative Stocks at Stockscape.com
Chris Bunka's advice on first steps for new investors - one of several interviews with Chris Bunka conducted by Stockscape.com
Chris Bunka Speech - Chris's speech to the Vancouver Investment Conference in January in RealVideo™ at 56 K. Also available at 28 K. If you are using RealPlayer V. 6.03 and have a problem with audio, upgrade to V. 6.05. Click on Help, then About RealPlayer and then Check for Upgrade.
Outsider's Overture Newsletter (at Canspec Research) - all back issues online except the most recent ones. This is a good place to go to read Chris's writings firsthand before deciding whether to buy his book or subscribe to his newsletter.
Outsider's Overture Newsletter (at Stockscape.com) - selected free articles online. There's also an Ask Chris Bunka Now section that lets you send Chris an investing question. He will respond by email.
Outsider's Overture Newsletter (at Stockhouse.com) - selected articles available online to subscribers only.
http://ram.insinc.ca/cambridge/bunka-28.ram

Disclaimer: As with all my columns here, I should re-iterate a precaution. I am not a professional financial advisor. I am a financial journalist and editorialist. The views in these columns are my personal opinions. The author may hold interests in investments mentioned in this article.

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