MARKETPLACE – Find Hot Deals in Kiplinger's New Marketplace SLIDE SHOW Best Index Funds for Every Investor QUIZ Will It Sink Your Credit Score?SLIDE SHOW Best Credit Unions Anyone Can Join, 2017 Stock Watch The Perils of Penny Stocks Paul Allen understands all too well the pitfalls of purchasing penny stocks.Last spring, Allen, a 65-year-old retiree from Boston, invested in Vapor Hub International (symbol VHUB) after receiving a flood of e-mails suggesting that shares of the e-cigarette company were about to take off.He quickly lost 80% of his investment.See Also: Beware Exotic Investment Opportunities Allen won’t be the last investor to suffer such a fate.The possibility that a stock will soar from a few pennies a share to a few dollars, or more, is too tempting to ignore, even if the potential for fraud is great.Consider how investors got sucked into a company called Cynk Technology (CYNK).Cynk, which had no revenues and just one employee, briefly enjoyed a market value of more than $6 billion, thanks to a promotional blitz that started in June and sent the shares soaring from 6 cents to nearly $22 in just a few weeks.

The Securities and Exchange Commission ended the party by suspending trading in the stock on July 11.When the SEC lifted the suspension on July 25, the stock sank 96% in two days.Advertisement Encouraged by a bull market and the exorbitant prices companies are paying to buy start-ups, more and more people are hoping to make a killing with penny stocks.e cigarette lys lez lannoyAccording to OTC Markets Group, where many tiny companies trade, some $26 billion in penny stock shares changed hands in 2013, up 46% from the previous year’s volume.macau e cigaretteThe apparent manipulation of Vapor Hub’s stock was typical.e cigarette luxe parisVapor Hub operates two retail shops in the Los Angeles suburbs where you can try different e-cigarette flavors.e cigarette rive sud

According to its March 31 financial statements, the company lost $6,048 in its first nine months of operation.And its survival depends on its ability to raise more capital—a prospect so uncertain the firm said its ability to stay in business was in doubt.But in April, two newsletters, Analysts Review and Investor-Edge, received $65,000 to promote Vapor Hub and began sending out rapid-fire e-mails about their top pick in the e-cigarette sector.e cigarette plcThe shares doubled in a matter of days, convincing Allen he needed to act fast.e cigarette plouayThe stock, which hit 87 cents in early April, closed at 11 cents on July 31.The SEC, which defines penny stocks as those that trade for less than $5 per share, says this market is unusually vulnerable to fraud for a variety of reasons: Few seasoned analysts follow penny stocks, financial information is scarce, and many supposedly unbiased reports are actually written by paid promoters.

The SEC doesn’t list enforcement actions based on market capitalization, but the agency has shut down hundreds of suspicious stocks in the past year.Advertisement Of course, plenty of legitimate outfits with tiny share prices—so-called micro caps—eventually grow into bigger concerns and reward shareholders.On average, about 50 firms graduate to larger exchanges each year, says Cromwell Coulson, CEO of OTC Markets Group.He says his exchange tries to curb fraud by making financial information more readily available and by adding a skull-and-crossbones warning to a company’s listing when the exchange learns that the stock is the subject of an e-mail campaign.But the warnings often come too late for individual investors such as Allen.The best way to avoid penny stock scams is to do independent research, says Ken Springer, a former FBI agent who conducts investigations for institutional investors.Start by visiting the SEC’s Web site.Look at a company’s 10-K annual report, 10-Q quarterly reports and Form 8-K filings, in which companies report “material” events.

Checking out promoters can be tougher, but some telltale signs are readily available.For example, disclosures on the Web sites of Investor-Edge and Analysts Review revealed that they had received payments from Vapor Hub.Says Allen: “I’ve been torturing myself over this.It’s not that I didn’t know the right questions to ask.It’s that I invested before I asked the questions.” Show commentsBy Dee Gill Tobacco companies have given shareholders wonderful post-recession returns, having doubled investor money before the rest of the market delivered a 30% gain.That's particularly galling for thousands of investors who avoid the tobacco sector on ethical grounds.You can see the price paid for sticking to those scruples in the stock chart below of total returns for Reynolds America (NYSE:RAI), Phillip Morris (NYSE:PM), Lorilland (NYSE:LO) and Altria (NYSE:MO) shares versus the S&P 500.PM Total Return Price data by YCharts Now, tobacco has a hot, some say honorable, new product.

Sales of electronic cigarettes are booming, and they seem to be weaning some smokers away from traditional cancer sticks.E-cigarettes deliver, supposedly, the pleasure of smoking without tobacco, smoke or their particularly horrible consequences.So is there finally a way for socially conscious investors to make money from nicotine?The core part of the investment thesis is very tempting.The global market for e-cigarettes, a mere $1 billion in 2012, is expected to top $3 billion by 2015, according to Citi analysts.Shares of Vapor (NASDAQ:VPCO), an e-cigarette-only company that makes Krave, Smoke 51 and other popular brands, are four times higher than they were when it got into the business in late 2009.(But of course it's a penny stock, trading for less than a dollar a share.A bit of investment research is warranted.)VPCO data by YCharts But the logistics of ethical investing here are tricky.First, even if they're helping some to give up tobacco, aren't e-cigarettes creating a new cadre of nicotine addicts?

While the nicotine-laced vapor that e-cigarettes deliver is probably safer than tobacco toxins and smoke, it's still nicotine.Regulators don't allow the industry to market e-cigarettes as a tobacco cessation tool, although evidence is building that they're at least as effective at this as (rather ineffective) nicotine patches.It may not be impossible to invest well in e-cigarettes without lining the pockets of big tobacco.tobacco companies have been launching their own e-cig brands, but 99% of all smokes sold are still the old-fashioned kind.Lorilland bought leading e-cigarette companies in the U.K.and the U.S., but nearly 90% of its revenues will still come from menthol cigarettes.There are few options for investing solely in e-cigarettes minus tobacco, and all of them are highly speculative.NJoy, which corners 40% of the market, is privately held.Vapor has a market cap of $54.6 million.VaporBrands International (OTCPK:VAPR) trades in the pink sheets, and Gilla (OTCQB:GLLA) is over the counter.

Their tiny sizes should make investors wonder if the companies can afford this business once regulators and tax assessors get around to making demands of this baby industry, which they surely will.The last time the law cracked down on tobacco, the biggest tobacco companies gained market share as small independents collapsed under the expense.It's true that investors in small e-cigarette companies could make out in takeovers, as companies like Reynolds and Lorilland are hunting for those sorts of acquisitions.But if you're buying the e-cig stocks as a more ethical alternative to tobacco shares, in takeovers you'd be collecting tobacco money just the same.The traditional tobacco stocks aren't all that cheap, based on trailing PE ratio.PM PE Ratio TTM data by YCharts But they're prized for massive cash flow and, generally, fat dividend yields.PM Dividend Yield (TTM) data by YCharts Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.