Bankruptcy is a legal proceeding in which a person or a company is unable to repay their outstanding debt. This happens when the debt has ballooned so high that the person or company is unable to even pay off the interests of the loan. Debt is a complicated financial tool which can accelerate the growth of the company when used correctly. But it can also lead to a debt trap which can make it impossible for the company to break free. Some examples of companies which have gone (or are close to bankruptcy) in India are Reliance Communication, Jet Airways, Alok Textiles, DHFL, etc. Every single one of these companies still trade in the stock market. And surprisingly, the stock price of all of these companies is higher than zero!
The most important reason why bankrupt companies still trade is because stock prices do not move based on fundamentals of the company. They instead move based on the supply and demand of the company. If you want to know more about why stocks don’t move based on fundamentals, visit this article! If there are sufficient buyers for a stock for whatever reason, the price of the stock will go up regardless of the fact that the company is bankrupt. But you might be wondering why would anyone like to buy stocks for a bankrupt company? There is a simple reason why many investors and traders buy bankrupt companies – expectation of a turnaround of the business.
There have been some famous companies which have come back after filing for bankruptcy! Marvel Entertainment which is famous for movies such as Avengers, Ironman, Thor, etc. filed for bankruptcy in 1996. Marvel was bought by Disney and is currently worth billions of dollars. A similar example is Tesla which was on the verge of bankruptcy in 2008. It is considered to be one of the most valuable companies in the world today with a 2.5% weightage in the S&P 500 index of the USA.
Even if a company is close to bankruptcy or is bankrupt, it can still remain operational for a very long time as long as it has a tangible business model. Consider a company such as Vodafone Idea which has been close to bankruptcy due to massive debt repayments. It is still operational to this day and the stock is still trading in the stock market. A bankrupt company doesn’t mean that it is worthless! Most companies have assets which have significant value and can be sold to repay debts or to keep the company running for sometime.
Companies can receive much needed capital during the time of bankruptcy in the form of government policies, big investors, issuing bonds, issuing fresh equity, etc. This infusion of capital can sometimes be enough for the company to survive a crisis and come back from the brink of bankruptcy. This is also a time where many speculators buy the stocks for the company in the hopes of making big money from a turnaround story. This is why it is never advised to short a stock simply because the company is going bankrupt. Because the stock price doesn’t always follow the fundamentals of the company. Such stocks are also a good target for big funds to pump and dump based on rumours about the company. Some speculators buy such stocks not in the hope of a turnaround but because they expect someone else to buy the stocks from them at a higher price. Even worthless items can increase in price as long as there is a buyer willing to pay a higher price.
Traders also love such bankrupt companies because of the high volatility which these stocks offer. A trader is simply looking at the price action of the stock and doesn’t really care about the fundamentals of the company. If the stock is having a good trading setup, it makes sense to trade in the stock in the hopes of making a short term profit in both long and short positions. To learn more about long and short positions, visit this article!
As a new investor, it is not recommended to invest in a company which is going bankrupt because the stock price can move based on speculation without a solid backing of the fundamentals of the company. There is no easy way to evaluate a company’s worth when the company itself is bankrupt. However, the final decision to invest or trade in a bankrupt company is for the reader to decide.
If you liked this article, share and subscribe to this website!
DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
- 4 Types of Stocks which Long-Term Investors should avoid! - May 6, 2023
- Why do some companies trade at a very low P/E multiple? - November 1, 2022
- Why most investors end up buying stocks at the wrong time? - October 26, 2022
