Buying stocks can be a smart financial move that can make you, or cost you, a lot of money. If you are considering purchasing stocks from a company in bankruptcy, there are things that may affect the value of your stock. Your investment can lose money and go to zero, or it can result in a profit. Bankruptcy is challenging to navigate, and for those considering purchasing stocks from a company in bankruptcy, the waters can be difficult to navigate.
Every publicly traded company is assigned an Altman Z score, which is a gauge that tests the likelihood that a company will go bankrupt. This score relies on several factors: profitability, leverage, liquidity, solvency and activity. A score below 1.8 means it’s likely the company is headed for bankruptcy, while companies with scores above 3 are not likely to go bankrupt. Investors can use Altman Z-scores to determine whether they should buy or sell a stock if they’re concerned about the company’s underlying financial strength.
Investing in a Bankrupt Company–Understand the Risks
Buying stocks from an insolvent company poses a certain amount of risk. If the company is publicly traded, company shareholders may be entitled to a portion of their liquid assets. Federal bankruptcy exemptions will determine what assets a company can keep after declaring bankruptcy. This will be largely contingent upon the type of bankruptcy a company files.
Bankruptcy Does Not Mean a Company is Going Out of Business
There are different types of bankruptcy that a company can file, and a filing does not automatically mean that the business is going to shut down. When an organization files for chapter 11, it does not automatically mean that the value of their stocks plummets to zero. When a company re-emerges from bankruptcy, often old shares of stock in the company are rendered worthless.
These shares are typically cancelled until the company restructures and issues new stock, which can sometimes take months or even years. A bankrupt company must pay off their existing debt before their bankruptcy can be cleared, and creditors typically receive shares of stock in the new company as payment, which leaves little for existing stockholders.
Buying stocks from companies in bankruptcy can be risky and can lead to financial loss, but, new shares can gain value for shareholders. If you own shares of stock from a company in bankruptcy, or are considering purchasing shares of a bankrupt company, take a look at the company’s website. You should also check their SEC filings available through the SEC’s EDGAR database or on the company’s website. Because it is a risky practice, if you are considering purchasing stocks from a company, it is important to do as much research as possible on the company you are looking into.