If you own shares in a company that goes bankrupt, there is an excellent chance your shares will end up worthless.
While there are exceptions to this rule, it's something that investors often misunderstand, in part because companies themselves usually emerge from Chapter 11. It's the common stock that almost never survives.
When a company declares bankruptcy, it's because it owes more than it can pay. To extricate itself from this, it works with banks and other creditors to create what can be thought of as a new company that doesn't owe as much money. Almost always, that company is one that current shareholders won't own shares in.
"Our experience is that you get very little return on equity after bankruptcy," said Chris Stuttard, editor of BankruptcyData.com, a clearinghouse for corporate bankruptcy information. "Look at it like this. It was one company going in and becomes a brand-new company when it comes out. And more often than not, the company will decide to cancel the old common stock."
This is because when it comes to getting paid back, equity stakeholders are dead last in line, trailing banks and debt holders. This makes trading in potential bankruptcy cases, for instance
, a particularly risky proposition, since the downside could very possibly be everything.
Consider the case of
, which entered bankruptcy last year and re-emerged as a new entity in the end of March.
A year ago, US Air shares were trading on the New York Stock Exchange as the company teetered into bankruptcy. After the company declared Chapter 11, the shares moved below $1 and were delisted, but still traded as over-the-counter shares as recently as March. Once the company left the protection of bankruptcy, whatever stake you owned instantly became worthless -- the company's old stock price is $0 and it isn't listed anywhere.
Because it had so many subsidiaries and moving parts, US Air's plan of reorganization is rather complex, but one thing is clear: Investors got nothing. "All of the common stock was reinstated, but those common shares are worthless," said Stuttard. "They might have reinstated that stock for tax purposes, but investors got nothing."
In rare instances, investors can hope to get next to nothing, perhaps one share for every 10,000 they own. Say, for example, this was how a potential AMR bankruptcy turned out. With AMR shares currently at $3.80 a share, if it declared bankruptcy and you owned $1 million in stock at that price, you'd get 26 shares back once the company remerged. You may as well have been wiped out.
"Institutional investors understand it but more often than not, individuals look at a company a year ago, and its goes to a penny, and for some reason they look at it and think it's going to go back up," said Stuttard. "They don't understand
what it means when a company is attempting to reorganize its balance sheet."