2023-05-04 23:13:12
Recently, Silicon Valley Bank parent company SVB Financial Group and Bed Bath & Beyond saw their shares drop as low as 71 and 28 cents before trading was suspended. (Photo: 123RF)
The stock market is often a rollercoaster ride, and no one knows that better than those who have invested in electric vehicle maker Nikola (NKLA). The company’s stock, once valued at US$67, has crashed and is now worth less than US$1.
So the question on many investors’ minds right now is: what happens when a company’s stock plummets to zero?
After all, this isn’t the first time this has happened. Recently, it happened to Silicon Valley Bank parent SVB Financial Group and Bed Bath & Beyond (BBBY), whose shares fell as low as 71 and 28 cents respectively before their trading halted.
In the past, we can think of the shares of Enron and Lehman Brother, which suddenly fell to zero or almost before being delisted from the Stock Exchange.
What does this mean for investors? Here are some answers:
When a stock hits rock bottom
If a stock falls to zero or near zero, it means that the company is effectively bankrupt and has no value for its shareholders.
On rare occasions, the value of a company might reach zero due to a moratorium imposed by the authorities for illegal activities or breaches of regulations.
There are a whole host of other reasons why a company’s stock might lose all of its value, such as poor management, poor financial performance, corporate-level fraud, or external factors such as unfavorable economic conditions. or mains disturbance.
A publicly traded company shows several signs of financial distress long before declaring bankruptcy. These include “over-leveraged balance sheets, inconsistently priced stock trading and a very high volume of insider trading, all of which point to a rout from senior management,” says Darren Sissons, partner and portfolio manager at Campbell, Lee & Ross.
Significant and persistent declines in profits and revenues, unfavorable reports from auditors and negative comments from debt rating agencies are also red flags. But, warns Darren Sissons “in terms of these last two groups, there are many cases where they have failed to capture the obvious data,” he warns.
The impact of bankruptcy on investors
The capital of an investor who would have placed his money in a bankrupt company is reduced to nil, and his investment is worthless.
Major stock exchanges have established limits for the minimum value a stock can reach before being delisted from their platform. Usually, if a stock’s price remains below a dollar for a certain number of days, said stock exchange will remove it from its listings. Once delisted, the stock is traded over-the-counter, and speculators can buy and sell it on alternative exchanges.
“Once bankrupt companies fall below minimum transaction thresholds, market makers drop using that name,” Sissons says. On the other hand, he adds, “it is not uncommon to see a name delisted from the shelves of the main Toronto Stock Exchange ending up on its Venture Exchange.”
When a company goes bankrupt, the investors in its debt conversion reinvest on the basis of that conversion and essentially become the owners of the company, Sissons notes.
“On the basis of this conversion” means a situation where those who invest in the conversion of a debt or the bondholders have the choice to convert the debt into equity of the company. That means debt holders become owners of equity capital, and “control of the firm reverts to the senior debt,” says Sissons.
Making profits with sinking stocks
Do investors have an opportunity to make money when a stock price crashes? Yes, said Mr. Sissons. “You can buy the bonds, which are likely to trade at a discount,” he said. If the firm is capitalized 50% in stocks and 50% in bonds, the value of the equity drops to zero, so the holders of 50% of the debt control the firm and convert the debt into equity. The company then becomes, in effect, debt-free.” Alternatively, investors can take options to buy or put the company.
“Any company can be reduced to bankruptcy”
Are companies in certain sectors more vulnerable to bankruptcy than others? “In theory, says Mr. Sissons, any company can be reduced to bankruptcy, but in fact it is usually established companies that have too much debt.”
“Fast-growing tech companies that continually incur net losses and then run out of cash are also at risk,” Mr. Sissons notes, citing the example of Canadian telecoms giant Nortel, which collapsed and declared bankruptcy in 2009.
If for any reason you find yourself owning shares of a company that does not have sound fundamentals, it is very important that you understand the risks upfront and ensure that this investment remains valid for your strategy.
Mr. Sissons has a simple piece of advice: “don’t buy companies that have a bad balance sheet. Read reviews from auditors and debt rating agencies, and hear regarding research and analysts’ notes.
But there are a lot of things to watch out for, and it’s a very time-consuming process. “If this work is too much of a burden, to help you, seek the services of a specialist in wealth planning,” he says.
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