Bankrupt Stocks: Bang or Bust?

12-01-2019 06:01

You might be asking yourself, “Why on Earth would someone invest in a bankrupt stock?” Well, sometimes, when stocks drop suddenly and steeply, fear sets in and investors sell. This lowers the price of the stock even more. Many investors are attracted by this lower price and believe this large decline can provide an opportune entry point. These investors believe this on account of the fact that the stock price is low and they are optimistic to make quick profits.

Generally, stocks get close to zero on the day of the bankruptcy, but can rise significantly—sometimes doubling or tripling. If investors choose to invest in a bankrupt stock, they could make some big gains. This method of trading, however, has no logic behind it. It is very unpredictable and risky to trade bankrupt stocks. Basically, an investor who buys a bankrupt stock is buying something with no value and hoping to sell it to someone else for more. This is an example of the greater fool theory, which is a theory that states it is possible to make money by buying securities, overvalued or not, and selling them at a profit on the belief that there will always be someone, a greater fool, who is willing to pay the higher price.

Companies try to avoid declaring bankruptcy because employees will lose their jobs and equity is put at risk in the company. Usually, companies declare or are encouraged into bankruptcy as a last resort. Liquidation is the first step after a company declares bankruptcy. If the company liquidates, it needs to pay back a whole chain of people before common shareholders are even considered. First, bondholders are entitled to claims of assets or payments from the bankrupt company. Second, the company needs to take care of payments for taxes, employees, trustees, and the like. Thirdly, preferred equity holders are given their share and, finally, the common shareholders get the remaining liquidated funds. It is highly unlikely that shareholders receive anything in the end.

Moreover, if a previously bankrupt company restructures, old shares are usually cancelled and payments to shareholders are written off. Shareholders ultimately receive no value from their old investments. That is why it is vital to consider pulling out of a company (selling all of one’s shares) when suspicions of the company going bankrupt emerge.

Let’s take the company GT Advanced Technologies (GTAT), for example, before it went bankrupt and became GTATQ. GTAT, last year, had a partnership with Apple, in which they had planned to supply Apple with sapphire material for the Iphone 6. During the first half of 2014, GTAT’s value doubled as a result of its partnership with Apple, which would prove to be revolutionary for GTAT. The deal fell apart, however, after GTAT was not able to meet its quota of sapphire material in time for the deadline both GTAT and Apple had agreed upon. When Apple announced that it was not in fact using the sapphire for its main display, but Gorilla Glass from Corning instead, GTAT’s shares plummeted.

On Monday, October 6, the stock dropped 1,375% from $11.07 to 0.75 cents. The next day, the stock opened at 0.95 cents and hit a high of $2.00. This volatility goes to show that one can make extremely profitable returns on a given day if traded very cautiously. However, one can also lose a tremendous amount of money if the stock fails to have any intrinsic value again. Just to put this into perspective, GTATQ is currently trading at 0.465 cents.