When a company files for bankruptcy, its stock takes a major dip, often selling for pennies. When this happens to a large, well-known corporation, some investors see this as an opportunity to buy stock in the company before it is either bought out or recovers on its own. If you would like to try your hand at this type of investment, educate yourself about the risks.
Understand Who Gets Paid
If a company rebounds or is bought out by another company after a bankruptcy, you may think that stockholders will automatically get a windfall. This is not generally the case. When a bankrupt company financially recovers, it must pay their secured creditors first, such as banks, followed by unsecured creditors, such as suppliers and bondholders. If the company does not have enough money to pay off its debts, stockholders will never see a dime.
During reorganization, it is also legal for a company to cancel existing equity shares or reissue fewer shares that are worth less than your original shares. Since this can happen at any time during a company’s reorganization, buying stock after a bankruptcy puts your shares in limbo. Even if the company doesn’t cancel or restructure its stock, a bankruptcy court can determine that the company does not have the funds to pay stockholders.
The company may also be unable to restructure enough to save the company and will then declare Chapter 7 bankruptcy. When this happens, stock will be wiped out completely and stockholders will receive nothing. According to the U.S. Securities and Exchange Commission, losing all of the money you invest the stock of a bankrupt company is much more likely than making profit.
When to Buy
The best way to be successful in buying stock in a bankrupt company, per Guerilla Stock Trading, is to purchase shares in a company that has an imminent buyer. If a company that has declared bankruptcy is bought out for $10 a share, the debts of the bankrupt company will become the debts of the new company and shareholders could be paid out at $10 per share. If the buying company chooses to reorganize, however, you may still end up losing money in the deal.
Where to Buy
If, after weighing the risks, you still want to purchase stock in a bankrupt company, shares will be available. Most of the time, companies that have filed for Chapter 11 bankruptcy will not meet the standards to trade on the New York Stock Exchange or Nasdaq. Trading occurs on Pink Sheets and the Over-the-Counter market, where standards are more lax. Online trading sites like NobleTrading and E*Trade permit the buying and trading of Pink Sheet and Over-the-Counter stocks. To use an online trading company, sign up for an account at the website, fund the account through credit card or check and begin to buy stock.