Go bust and die trying....

Dear Congressman,

As an accountant, I occasionally get questions about whether or not it is worthwhile to buy stock of a company that has declared bankruptcy. It appears it is very tempting to individual investors when the shares of a once proud mega-giant of American industry is trading on the stock exchanges for (usually) less than a buck a share.

Which leads to my usual response.

There is a reason that it is trading for less than a buck a share. It is worthless. Zero, nil, null, nada, nothing, zip.....

Let me see if I can explain.

As a stockholder, think of yourself as standing at the edge of a cliff. Directly in front of you are unsecured creditors, with secured creditors (think bondholders and banks here) standing in front of them.

Companies can generally file two types of bankruptcy in the USA. So we have two scenarios to cover.

First is the dreaded Chapter 7, which means the company does not see any chance of recovery and is going to sell it's assets to pay off as much as it owes as possible. In this case, the attorneys for the company basically push everyone off the cliff. The people who land on top of the others will generally be uninjured and walk away with out taking a hit. This would be the bankers and the bondholders. The next layer of people would be injured in some way but still survive to fight another day. You however, the stockholder, are either killed when you hit the ground or crushed to death when everyone falls on you. You get nothing and like it....

Second is a little thing call Chapter 11. In this case, the company decides it can not possibly pay all its bills on time but thinks they can become profitable again, if only they can call time out, ditch some of there past mistakes, and then move forward like nothing happened. For a Chapter 11, the attorneys don't push everyone as hard as they do in a Chapter 7, thus the only ones who fall off the cliff are the stockholders, as their capital in the company is redistributed to everyone else in front of them. Thus, after the shove, some of the unsecured creditors and other debtors are given company stock in lieu of their prior claim, so after the dust has settled there is a whole new set of stockholders standing at the edge of the cliff. Again, lying dead at the bottom of the cliff, you get nothing and again like it....

So why do shares trade for pennies when they are in fact worthless. Guess what folks... it's basically like playing musical chairs, only at the end of the game they remove all the chairs....