When Stocks Go to Zero

The percentage fall in the valuation of the stock market is, pretty much by definition, lower than the percentage fall in the enterprise value of America, Inc. And the more levered that America Inc. was, the greater the difference between the two numbers.

But with a lot of high-profile stocks now trading in the low single digits (Citi, Ford, GM, airlines), and even General Electric trading at just $13 a share, the optics of what's going on, especiallly among retail investors, are atrocious. I just got an email from Portfolio's travel guru, Joe Brancatelli:

I've noticed people get REALLY nervous when shares of a company start costing less than a cup of joe at Starbucks. It's sort of the dumb-guy's-guide to the market. If I can buy shares for less than coffee, things are bad.

Well, yes, when a multi-billion-dollar corporation sees its equity wiped out, things are certainly bad. And nominal stock prices do matter, for reasons I don't fully understand: Somehow it's worse that Citi's gone from $35 to $5 than it would be if it had gone from $105 to $15.

But the whole leverage aspect I think is not well understood by the public. They know that if they buy a house with little or no money down, that means they have very little equity in the house and that equity can be quite easily wiped out, even if the house is still worth something. But they don't look at stocks the same way: They don't think of shares in Citigroup (C) as equity in a house with a 90% mortgage while Apple (AAPL), say, bought its house for cash.

If enough stocks go to zero during this stock-market downturn, that might change. Especially if and when companies start emerging from bankruptcy in listed form, the public might start to realise that companies don't necessarily die along with their stocks, it's just that their owners change. But for the time being, and for the foreseeable future, the news is likely to get worse before people start to see through to the other side.

Disclosure: No positions in any of the stocks mentioned.

Comments

[Smarty_Pants:]

"The percentage fall in the valuation of the stock market is, pretty much by definition, lower than the percentage fall in the enterprise value of America, Inc."

Perhaps, but you ignore the fact that the valuation had probably risen a great deal more than the enterprise value for years before it peaked.

Just because GM traded for $90 didn't mean it's enterprise value was actually that high. In fact, it was much, much lower as we are discovering now. It was probably more appropriately valued at less than that cup of joe and is only now truly reverting to a meaningul price level.

2008 Nov 21 11:06 AM

[Alan in Hon...:]

When shares cost less than a cup of coffee, I tend to not buy the coffee because I think about how many share I could be missing out on buying. Maybe I'm weird? Needless to say, I drink a lot of coffee at home now.

2008 Nov 21 11:19 AM

[Josh Stern:]

I use screens to find stocks that are cheap by many metrics including the ratio of enterprise value (EV) to free cash flow, typically finding companies with EV that is much lower than their market cap due to lots of cash on the balance sheet and little or no debt. And I can tell you from experience that holding such stocks has been an exercise in pure pain over the past few months. From a rational POV, all the stuff mentioned in this article is important and may matter in the future, but so far it hasn't mattered one iota in the Panic/Crash of 2008. There are lots of small companies selling for less than cash, and they just keep going down too.

2008 Nov 21 12:09 PM

[Paulo:]

If a lot of high profile stocks are now trading in single digits, how does this affect U.S. institutional investors? Is it when a stock falls below $5 or something that it creates problems. If so, does this also apply to equities in the form of American Depository Receipts?
Just wondering, because this might cause movements in high profile stocks now in single digits!

2008 Nov 21 12:21 PM

[akapital:]

"Especially if and when companies start emerging from bankruptcy in listed form, the public might start to realise that companies don't necessarily die along with their stocks, it's just that their owners change."

As an investor who has seen one holding go to bankruptcy I am particularly intrigue by your closing comments. Are you suggesting that buying shares of potential bankruptcy candidates and/or future bankrupt companies might become a value investing strategy? I have no comment either way but I wonder about the obligations these listed companies have to pre and post bankruptcy shareholders. Are the obligations the same? I would want to do alot more research before buying listed shares of a bk co and understand the legal obligations they have to shareholders.

2008 Nov 21 01:11 PM

[icy:]

none nada zip zero in Chinese, ying


That is what your share of common is worth at bk


On Nov 21 01:11 PM akapital wrote:

> "Especially if and when companies start emerging from bankruptcy
> in listed form, the public might start to realise that companies
> don't necessarily die along with their stocks, it's just that their
> owners change."
>
> As an investor who has seen one holding go to bankruptcy I am particularly
> intrigue by your closing comments. Are you suggesting that buying
> shares of potential bankruptcy candidates and/or future bankrupt
> companies might become a value investing strategy? I have no comment
> either way but I wonder about the obligations these listed companies
> have to pre and post bankruptcy shareholders. Are the obligations
> the same? I would want to do alot more research before buying listed
> shares of a bk co and understand the legal obligations they have
> to shareholders.

2008 Nov 21 01:22 PM

[Kofi Bofah:]

Um er ah.

Your title brings me to believe that we will be living in huts shortly.

2008 Nov 21 03:28 PM

[Boubou:]

Kofi, your comment reminds me of something Cramer said last week in a fit of honesty on a late chat show. It amounted to recommending 'Little house on the prairie' for a guide to getting through the next few years.

2008 Nov 22 08:30 AM

[kurt walter:]

Eat rice and beans. Drink tap water. Buy nothing that is not essential to survive. Survival mode. .. Best move? Turn off the TV, don't listen the the radio, don't read the newspaper. All 3 do little more than sell fear and irrational thinking. You don't need that negative downer stuff in your head.

2008 Nov 22 01:24 PM

[kmne68:]

There seem to be values all over the place but with limited funds I am not sure which apple to pick.

Anyone see a problem with just dollar cost averaging into an index ETF over the next few months/years so that whent the tide does come in I am ready?

2008 Nov 22 01:37 PM

[Teutonic Kn...:]

Stock price is only a form of "illusion". If the company's business model is outdated and the market conditions are deteriorating, then that equity "price" could easily become zero. In other words, the price is a only in the eyes of the beholder (the investor). For example a well-known telecom manufacturer (and I do not explicit name it here; you could guess it for yourself), it was a multi-billion dollar market value international company. But its stock price recently dropped to less than 50 cents. Sure, if you a multi-millionaire with lots of cash, you could just go into the open market and buy it outright (over 50% gaining control). The company has beautiful college campus-like R&D labs clustered in serene lakes and forests. You then become the dominant owner! The next day you will find that you have to meet payrolls and all that burn-rates in cash, and to pay people severance just to fire them, thousands of them. And all that debt, preferred shares, bonds to tangle.

The point I am trying to make is that the stock price (common) of a company could EASILY be reset to ZERO. There is no sacred cow in business.

2008 Nov 22 02:18 PM

[Bobco23:]

If you have an investment horizon of 5 years or more I think this is an excellent strategy. If the market recovers, which is likely, you could see a double or tripple. If the market does not recover, possible but unlikely and disasterous for all asset classes including cash (e.g. Post WWI Germany), your EFT's will be next to worthless. But this is a good risk reward here for the intermediate term investor. I am averaging in on individual stocks over the next two years, focusing on dividend stocks (those that are likely to be able to maintain dividends like PM, FPL, OKS and CVX. Your plan has better diversification; mine better cash flow. I like both.


On Nov 22 01:37 PM kmne68 wrote:

> There seem to be values all over the place but with limited funds
> I am not sure which apple to pick.
>
> Anyone see a problem with just dollar cost averaging into an index
> ETF over the next few months/years so that whent the tide does come
> in I am ready?

2008 Nov 22 10:14 PM