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Narrator: So you bought a struggling stock, maybe hoping to get a former high-flyer on sale and profit from a big corporate turnaround. But things didn't go as planned, and the company filed for bankruptcy. What now? I'm going to walk through what happens when a public company goes bankrupt and what it means for shareholders. And stick around for tips on how to avoid companies at risk of bankruptcy.
Companies typically file for bankruptcy when they can't meet their financial obligations like debts. Bankruptcy is a legal process for determining how any value left in the company can be best used to repay what it owes. There are two main types of corporate bankruptcy: Chapter 7 and Chapter 11. Under Chapter 7, the company stops operating altogether, and any assets it has are sold to pay as many of its obligations as possible. Under Chapter 11, the company continues to operate while it restructures agreements with its creditors and formulates a plan to reorganize and reemerge post-bankruptcy.
But declaring bankruptcy doesn't mean the company's shares suddenly go to zero or disappear—at least not yet. Bankruptcy proceedings can take months or even years. During that time, people can often still buy and sell the stock. However, in bankruptcy the stock will stop paying dividends and may be delisted from major exchanges.
Typically that means trading over-the-counter, where there aren't the same financial reporting or minimum price requirements. Stocks of bankrupt companies often have a "Q" added to the end of their ticker symbol to warn investors that the company is bankrupt.
The important thing for stock investors to know is that shares of a bankrupt company are very likely to end up worthless. Under bankruptcy law, debt is more senior than equity. In other words, creditors get first dibs on whatever value is left in the company, and there's usually nothing left for common shareholders. Even if the company continues to operate and reorganizes to emerge from bankruptcy and issue new shares, its original shares usually end up canceled and worthless... usually.
Animation: Image of a CNN Business news story from May 24, 2020 with the headline "Hertz files for bankruptcy."
Narrator: The car rental company Hertz filed for bankruptcy in May 2020 in the face of rising debt and dwindling business prospects in a world of pandemic lockdowns.
Animation: Image of a Business Insider article with the headline "Billionaire investor Carl Icahn dumped all of his Hertz shares at an almost $2 billion loss after the car-rental giant's bankruptcy."
Narrator: Activist investor Carl Ichan dumped his massive position expecting the shares to end up worthless.
Animation: thinkorswim® chart showing Hertz stock's volatile decline June 2020 through March 2021 before a major rebound in March through June, 2021.
Narrator: But as the stock moved toward zero, highly speculative traders began piling in, sensing a chance to win big if the stock had a miraculous turnaround. This was an extremely risky bet, but about a year later, an investment group bought Hertz out of bankruptcy.
Animation: Image of a Bloomberg article from May 12, 2021 with the headline "Hertz Shares to Recover $8 Each in Knighthead Win; Stock Soars."
Narrator: As part of the agreement some Hertz shareholders were entitled to recover what was valued at about $8 per share, well above the stock's lowest close at $0.40. But these scenarios are extremely rare. Just ask the shareholders of Bed Bath & Beyond.
Animation: Image of a New York Times article from April 23, 2023 with the headline "Bed Bath & Beyond Files for Bankruptcy."
Narrator: After the company declared bankruptcy in April 2023, some traders held onto or bought BBBY in hopes of a Hertz-style comeback.
Animation: thinkorswim® chart showing Bed Bath and Beyond stock's volatile decline throughout 2023 before shares being cancelled in September 2023.
Narrator: But that didn't happen, and the shares were officially cancelled in September of 2023, leaving BBBY shareholders with nothing.
So if you own shares in a company that goes bankrupt, you basically have two choices: First, hold on for the remote chance that the company emerges from bankruptcy with any value left for shareholders. This is extremely speculative, and only something to consider if you could afford to lose your entire investment. Or you could cut your losses and sell shares while there's still some value, though likely still at a significant loss. Keep in mind that the longer you hold the shares the harder it could be to find a buyer.
Neither of those are great options. That's why it's best to avoid owning stock in a bankrupt company to begin with. Here are a few tips:
First, do your research before buying a stock. This doesn't mean reading theories on internet message boards. It means analyzing a company's financial performance and outlook and reading reports from trained analysts. Growing earnings, high profit margin, and low debt-to-equity ratios can all suggest a company is on strong financial footing. Be careful when buying the dip. There are many times when a stock price plummets for good reason.
For stocks you already own, keep an eye on their financial performance. Pay attention to quarterly earnings reports and news about the company. If your original thesis about the success of a company proves to be wrong, or its fortunes change, consider selling. Don't be misled by internet personalities encouraging you to hold at all costs.
Be careful when buying the dip. There are many times when a stock price plummets for good reason. If you choose to make a speculative investments, only risk money you can afford to lose.
While investing in stocks always comes with risk, doing your homework and carefully monitoring your investments can help you avoid holding a worthless stock from a bankrupt company.
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