Bankruptcy is without a doubt the most disturbing word in the language of investing, and for proper reason. Equity investors know, or soon will, that an investment in a company that goes bankrupt means you lose all of your money. You could even lose more than you invested if you are using margin. Creditors, which include bond holders, get any assets that are available, and shareholders are almost always left with nothing. Only those that bet against the company before the bankruptcy, either by shorting the stock or by other means, as well as a few strategic bond traders, will make a profit. Shorting a stock before the company goes bankrupt almost always yields an immediate 80% return with a high probability of that return eventually going to 100%.
Do not think it is a quick death either, in fact, it is quite the contrary. The equity that is left gets chopped up and immediately delisted to the Pink Sheets, where a fifth letter 'Q' is added to the symbol. Often, the stock is organized into a new entity entirely, or a holding company. The best time for a long investor to get out of the stock is always as soon as possible. When World Com went under, investors who sold earlier in the day made out a lot better than those who sold at any time after that. Some enterprising investors may try to sell the stock right away, then buy some back at the bottom and hope for the dead cat bounce that usually follows. This is a precise game where victory is breaking even, and defeat is losing twice as much as you would have in the first place.
These stocks bounce around quite a bit, and occasionally see significant pops, but the end game is always zero. The stock will wither away slowly down to a penny, then below a penny, then below a tenth of a penny until it either flat-lines or gets pulled entirely. Take a look at Circuit City (OTC:CCTYQ). The company was bought by a hedge fund and was turned private. All bricks and mortar locations were closed, but the online store remained. The stock continues to trade on the Pink Sheets, but has lost almost all life. Take a look at Mesa Airlines (MESAQ.PK). The stock trickled down slowly into sub penny land, then the last wave of selling hit just before the company announced it was emerging from bankruptcy, going private, and canceling all outstanding shares.
Nevertheless, a significant number of traders flock to bankruptcy issues. Experienced high risk day traders find enormous short-term percentage swings. Some traders specialize in bankruptcy issues. For the average investor or trader, however, these stocks may be a mistake. Some may simply be fascinated that such a well-known name can be trading for pennies a share. Others may be drawn to the heavy volume and the large percentage swings. Either way, trading bankruptcy issues requires absolute precision, experience, intestinal fortitude and luck. The vast majority of traders and investors, even those not adverse to significant risk, will certainly find better investments elsewhere. Here are a few issues garnering quite a bit of attention right now, despite being wholly worthless.
Borders Group Inc. (OTC:BGPIQ)
Even before becoming the nations ninth largest company to file bankruptcy on February 16, Borders was headed in a downward spiral. The stock was already down 75% on the year after another quarter of declining revenues and unsustainable losses. The company has been able to secure half a billion dollars in financing from GE (NYSE:GE) Capital, whereby they can continue to own and operate some stores and sell others, but if they do not meet the terms of the financing, GE will take possession. Although the balance sheet is bad and getting worse, that is not where the main problem is. Companies like Amazon (NASDAQ:AMZN) and Wal-Mart (NYSE:WMT) online have eaten away at Borders' business model. It has failed to build up its online division, and even failed in an E-Reader attempt. It is simply too late, and Borders is too far behind to catch up now. BGPIQ is in the early life stage of a bankruptcy, so this soon-to-be dead fish will continue flopping around while Barnes and Noble (NYSE:BKS) tries to fillet it. Whats left over in the end will probably be snatched up by a hedge fund.
Blockbuster Inc. (BLOAQ.PK, BLOBQ.PK)
Blockbuster is a bit further along in the process having filed for bankruptcy protection in September of last year, and the hedge funds are already circling. This business model is further along in the process of deterioration, as well. Blockbuster survived and even thrived for a little bit after Hollywood video and the Movie Gallery consolidated and failed together, similar to what Barnes and Noble may experience. The company had a couple of ideas in the mid 2000's, including Blockbuster by Mail to compete with Netflix (NASDAQ:NFLX), and the elimination of late fees. Blockbuster tried to buy Hollywood video in 2004 as it was failing, and even considered a bid for Circuit City in 2008. In 2009, blockbuster began rolling the kiosks out in an attempt to compete with the already established Redbox by Coinstar (NASDAQ:CSTR). The company went on to accumulate over a billion dollars in debt, and was forced to dismantle. Some positive action in the stock over the past few months should not be mistaken as any materially positive news for shareholders. The stock is simply trading on momentum related news of more favorable conditions for debt holders than were previously expected. This means that the stock is trading on a false premise; there is still no indication that stock holders will get anything at all in the end.
Nortel Networks Corp. (OTC:NRTLQ)
This stock is the furthest down the slide of these three issues, and a purchase now will likely yield an immediate and total loss. To see exactly what you are getting for your two cents, lets take a look at the financial statements. The company had over 10 billion dollars in revenue for all of 2008. During the most recently reported quarter ending December 31, 2010, revenues were $28 million, and the cost of revenue was $40 million. Overall, the company lost more than $2 billion in that quarter alone, and Nortel finished the year with $4.5 billion in quickly depreciating assets, and over $11.5 billion in quickly appreciating liabilities. Not only is this stock completely worthless, it is starting to get hard to get in and out of.
No positions in stocks mentioned. Penny Stocks Weekly is completely unbiased; we accept no compensation, in any form, from any of the companies we write about, or from any third parties. See all of our latest, unbiased articles here.