-The Bad -
What is 'Dilution'?
-'Dilution' is the issuance of additional shares to the 'outstanding share count'. While not such a bad sounding definition, the impact of dilution can ruin a shareholder's position in a stock. The additional shares effectively 'dilute' the value of all shares on the market. Think of it like a pizza. The pie represents the market valuation of the company, while the slices represent the individual shares of the company's stock. When the company sells new shares, the pie doesn't get bigger, the slices simply get smaller. The investor is left with smaller slices.. or.. cheaper shares. Dilution Definition
The direct effect of selling new shares can often be far more damaging than the proportional increase in shares warrants. Selling shares on the open market drives down the price; supply is increased, while demand stays the same. Without care a company can send their stock into a diluted spiral that is very damaging to shareholders.
The purpose of dilution is for the company to raise money, plain and simple. In the grand scheme, the purpose for a company to go public in the first place is to provide a means for raising capital. You must find companies that do so in a responsible manner, without hurting shareholders. Always keep this in mind when trading any stock, and you will fall victim to dilution far less often.
What is a 'Reverse Split'?
-A 'Reverse Split' (or R/S, RS) is a method by which a company reduces the number of shares on the market and increases the stock price proportionally. Reverse splits are done at a specific ratio: ie - 10 for 1, or 10:1. This ratio would mean that if a shareholder held 1000 shares at 1 cent, after the reverse split the shareholder would be left with 100 shares at 10 cents each. The value of the position does not change from the reverse split... at least not directly from it.
Companies usually do a reverse split to increase the price of the stock to more attractive levels, or to remain at a minimum price for a particular exchange. While not necessarily a bad thing, a R/S is a popular method that bad penny stock companies use to continue raising capital through dilution. 'Dilution', if done enough, will eventually leave a stock virtually worthless. The price may go as low as .0001 dollars, the minimum that stocks are tradable by common investors. At this point the company can no longer effectively raise capital by selling more shares.
By performing an R/S, the number of shares on the market decrease, and the price increases back to a "dilutable" level. The dilution starts again, and the cycle can continue over and over. Because of this, a black cloud is associated with the R/S. They normally result in a large selloff by remaining shareholders, causing the price to plummet, and the shareholder value to follow suit.
A reverse split is very rarely an opportunity for a safe investment, and certainly not a wise choice for a beginner in penny stocks. To protect yourself from purchasing the stock of a company with a history of abusive reverse splits, check out this iHub board and scan through the list.: Reverse Split Repeat Offenders Listing
What is a "Gagged" Transfer Agent?
-A 'Transfer Agent' is a company's means of managing shareholder records, issuing and canceling stock certificates, and processing investor mailings. Some companies can act as their own transfer agent, but most often, especially with penny stocks, the job is outsourced to companies specializing in the business. Transfer agents are normally the most accurate, and often the only way of finding the current O/S, A/S, and float for a penny stock. Some will require a fax with shareholder details to retrieve the information, others simply a phone call or email. This type of transparency is desirable among investors.
A "Gagged" transfer agent is one which has been instructed by the company they are working for to not release information, such as the share structure. This is usually NOT a good situation. There is no legitimate reason for a company to gag their TA. It is almost always done to hide dilution. Some TA's, however, have a policy against releasing share structure information. The reasoning behind this is to keep the thousands of penny stock traders from bogging down their business with requests for information. Unfortunately this forces the shareholder to contact the company for information. While this isn't as bad as a company specifically gagging their TA, it still isn't an ideal scenario. Whether the company sought out this TA because of this policy, or it was a coincidence, is up for debate.
Without knowing the current number of outstanding shares, an investor has no idea if shares are being sold by the company. Concurrently, without knowing the number of authorized shares, the number of shares that can possibly be sold is not known either. Companies that practice this scam will often issue press releases, or other investor communication containing excuses for having the TA gagged. Unknowing investors will buy these up, and continue holding shares, or even buying more. We do not recommend touching a stock with a gagged TA, unless you are experienced with penny stocks, and it is purely a short term momentum play.