Some investors see the troubles in the mortgage and real estate industries as an opportunity to go bargain hunting for depressed but basically solid stocks.
And then there are some who buy stock in companies that have filed for Chapter 11 protection, betting that these distressed shares, now trading for pennies, will rise rapidly once the companies emerge from bankruptcy.
If you count yourself among the latter group, you would be better off going to play a slot machine.
The fact is if you own stock in a company that has filed for bankruptcy, chances are that stock eventually will become worthless. What many common shareholders fail to realize is that the owners of a company under bankruptcy protection are last in line for claims on any assets.
Take for example the Melville, N.Y.-based American Home Mortgage Investment Corp., once a major mortgage lender. The company announced in early August that it would no longer originate new loans. Then the company filed for Chapter 11, citing troubles in the secondary mortgage and real estate markets. On Aug. 13, the company's stock closed at 28 cents. That's down from a 52-week high of $36.40.
In its press release, included in a Securities and Exchange Commission filing, American Home Mortgage said: "While the Chapter 11 process is intended to help preserve and protect the value of the company's assets, it is highly unlikely that these values will be sufficient to pay its creditors in full, and that it is realistic to conclude that ultimately there will be no shareholder equity value remaining."
If you're a shareholder, don't expect to get anything. Although the company may emerge from bankruptcy, in all likelihood its plan of reorganization will cancel the existing equity shares.
Why would an individual investor buy stock in a company under bankruptcy protection? On Aug. 13, American Home Mortgage had a trading volume of more than 1.8 million shares.
Some of that trading could be shareholders trying to lock in their losses for tax purposes, said R. Cromwell Coulson, chief executive officer of Pink Sheets LLC, the electronic quotation system and leading provider of pricing and financial information for stocks sold over the counter.
And some of the trading is likely being done by investors who don't know what they're doing, Coulson said.
When companies can't meet the listing requirements to trade on the Nasdaq or the New York Stock Exchange, they are delisted. But shares may continue to trade on either the Over the Counter Bulletin Board, otherwise known as OTCBB, or the Pink Sheets.
Companies in bankruptcy have the letter "Q" at the end of their ticker symbol. If you go to the Pink Sheets Web site (www.pinksheets.com) and type in the symbol for such a company, a big red "Warning" box comes up with a link to the SEC's Web site with information on corporate bankruptcy.
However, such warnings often go unheeded.
Kmart made retail history in 2002 when it became the largest merchant ever to seek bankruptcy protection. In its subsequent filings with the SEC and news releases, the company made it clear that the old stock would be canceled and that buying it was highly risky. And yet the day Kmart and its U.S. subsidiaries and affiliates emerged from Chapter 11, 91 million shares of stock changed hands before trading in KMRTQ was canceled.
Kmart survived bankruptcy. The company issued millions of shares of new common stock, much of it to creditors. Individual investors holding the pre-bankruptcy stock felt cheated.
At some point, a company operating under bankruptcy protection will file a "plan of reorganization" outlining how assets will be distributed. The company also files its proposed plan with the SEC, attached to a Form 8-K. You can find the form by going to www.sec.gov and clicking on "Search for Company Filings." Then click on "Companies & Other Filers."
Look for the section that spells out what will happen to the common shares. And then wait until the company's final plan has been approved by the court to see whether the shares will be canceled.
But when a company says early in the process that it's extremely doubtful there will be any shareholder equity left if emerges from bankruptcy, take the company at its word.