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 will eventually 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 news 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.” Simply put, 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.
So my question is: 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.
No question that companies can emerge from a Chapter 11 and go on to operate successfully. But if you are caught holding the old stock, you aren’t likely to benefit from a rebound.
“Unsophisticated investors should stay away from stocks of companies that are in bankruptcy,” Coulson said.
Contact Michelle Singletary c/o The Washington Post, 1150 15th St. NW, Washington, DC 20071 or at singletarym@washpost.com.
