When a single mother of two from Ridgeland, who didn’t want to use her name, worked for a publicly traded company, she took advantage of the company’s stock purchase plan, often spending extra money on additional stocks instead of luxuries or vacations.
“I thought I was responsibly planning for the future,” she said.
When stock prices dropped to $10, on the advice of an investment counselor, she purchased more. When it dropped to $6, she scooped up more, expecting a rebound. When it dropped to $1.50, she hesitantly purchased even more, hoping it might still be a bargain.
But after the company filed for bankruptcy protection and the stock plunged to a nickel a share, she said, “I learned my lesson. I decided not to buy anymore.”
“I’d advise against it unless the money used to buy stock from a bankrupt company was aggressive speculative capital. More often than not, you’ll get nothing back — or a bad return,” said Stacey Wall, president of Pinnacle Trust in Ridgeland. “For everyone that makes something in a situation like that, there are a thousand people with stories of losing money. That’s bottom fishing to the hilt. You’re not only going to the bottom, but you’re digging a hole when you get there.”
Gulfport-based Friede Goldman Halter (OTC: FGHLQ) posted a second-quarter loss of $9.2 million, nearly half of what the company reported over the same period last year. Its stock was delisted after the company filed for bankruptcy protection in April, but still trades under the ticker symbol FGHLQ.OB and closed Aug. 14 at 55 cents a share.
“When a company files for bankruptcy, generally the stock is delisted for a brief period time,” said J. Harmon Bays, a financial advisor with Legg Mason Wood Walker Inc. in Jackson. “When the company begins trading again, it is usually traded on bulletin board exchange.”
Nancy Lottridge Anderson, CFA, a financial advisor and president of New Perspectives Inc. in Clinton, advises against buying stock in bankrupt companies.
“There’s too much risk, even though some people will insist on doing it,” she said. “It’s like going to the casino and pulling a handle on a slot machine and losing everything. The companies already don’t have cash to pay off creditors. There’s a hierarchy of repayment and generally vendors are at the top, then bondholders and preferred stockholders. If you’re a common stockholder, you’re the last one to get paid.”
One way to successfully invest in a financially troubled company — before it files bankruptcy — is to buy the debt, not the equity.
“Perhaps a way to profit from a company that’s about to go bankrupt is not to buy the stocks, but to buy the bonds if you can get them,” said Walter Neely, Ph.D., a professor of finance at the Else School of Management at Millsaps College in Jackson. “WorldCom had a lot of those bonds in Wireless One, and they ended up buying the rest of the company, essentially controlling the company through the senior debt and not the equity.”
Other than trading on the sharp, short-term swings that bankruptcy stock sometimes takes, there have been only a few examples where investing in bankrupt companies would have been profitable in the last few years.
If a basically healthy company is distressed because of a particular problem, such as a hefty legal liability, it can often be isolated and resolved.
“Perhaps there’s a legal problem, like in Texaco’s case,” Neely said.
If a company reorganizes under court protection, the restructuring process can take several years. If the company manages to avoid bankruptcy, it may take as long as five years before the stock market recognizes a successful turnaround.
Other considerations before investing in a bankrupt company:
• A company’s likelihood of restructuring successfully is significantly enhanced when at least one line of business provides immediate cash flow, there’s an opportunity for future growth, and if some assets can be sold without destroying the core business.
• Industry-wide problems vs. specific company problems should be taken into account.
• Studying the list of shareholders often provides a telltale sign. If management owns a significant share, they have a vested interest in a successful turnaround.
A management change can alter a troubled company. Sunbeam CEO “Chainsaw Al” Dunlap was ousted in 1998 when his promised turnaround fell short. But under the leadership of Jerry Levin, Sunbeam is successfully emerging from Chapter 11 bankruptcy protection. Well-known products or brand names, like RJR Nabisco, can be valuable to distressed companies.
“RJR Nabisco came back and generated nice rewards for stockholders,” Anderson said. “You just have to look at the company and the management and the product and see if they have what it takes to come out the other side. The motivation to invest in a bankrupt company would occur if you are convinced it will come back and be a viable business once again. If not, why do it?”
Contact MBJ contributing writer Lynne Wilbanks Jeter at email@example.com or (601) 853-3967.