Investors face big risks when buying bankrupt companies' stocks

Posted: Friday, December 20, 2002

NEW YORK (AP) -- A cheap ticket? Don't count on it getting you too far.

Shares of United Airlines' parent UAL Corp. have been surging lately, although the troubled carrier recently filed for bankruptcy protection.

And it's not the only bankrupt company whose stock has shown some strength. The list includes WorldCom, Enron and Kmart, too.

There's a reason, though, that these stocks are so cheap.

Buying them is nothing more than playing a game of chance.

Business fundamentals at most of these companies are still a mess, though cost-cutting is inevitable while they operate under Chapter 11 bankruptcy protection.

For shareholders, the real issue is what happens when these companies emerge from bankruptcy. In most cases, those holding common stock go to the end of the line of creditors.

So if you think you can buy now at reduced prices and hold them until a leaner company comes out of bankruptcy, there's a good chance you'll walk away with nothing.

''Shareholders usually get completely wiped out,'' said Stephen P. Wetzel, professor of financial planning at New York University. ''There is no equity to give out after you pay everyone else.''

Still, there have been spurts of strength in many of these stocks.

It makes you wonder why.

Fueling some of these gains are institutional investors. They aren't buying for the long term; they hope for a quick uptick in price and then sell fast.

Short-sellers are also at work. They make money by taking advantage of the fact that most of these stocks are well below their highs of the year.

Shorting a stock works like this: You borrow a share valued at $100 from a broker, and then turn around and sell it. When the price falls to $85, you purchase one new share.

You then give that share back to the lender and pocket the difference between the price you borrowed it at and the new price: a profit of $15.

So the short-sellers who are buying these bankrupt stocks aren't doing it because they have renewed confidence in the companies. They are just trying to close out their positions.

It's easy, though, to see why individual investors might be tempted by the stock gains.

In today's tough market, where big gains aren't seen too often, rallying stocks get noticed.

United's stock, for instance, surged last week to $1.75, nearly double what it was when it filed for bankruptcy Dec. 9. It is now trading around $1.50.

That, though, is still sharply lower than its 52-week high of $17.90 in March.

Enron shares surged last month, climbing 80 percent over a week even though the company has said outright that its stock has no value. Kmart's stock jumped 26 percent early this month after some positive retail sales news for the Thanksgiving weekend.

WorldCom stock more than tripled in value in November, with a big surge coming after former Compaq Computer and Hewlett-Packard boss Michael Capellas was named chairman and CEO.

But those gains at Enron, Kmart and WorldCom have mostly vanished, just another reason why individual investors should stay away.

It's too risky to play in this part of the market.

You don't have the financial backing that the large institutions do. If the stock drops to almost nothing, it won't destroy their portfolios, but it could hurt yours.

In addition, there is great volatility in these stocks, especially those like WorldCom and Enron now trading on the over-the-counter market rather than on one of the large stock exchanges.

That makes the timing of when you buy and sell even more crucial, something that's generally difficult for most small investors to do.

''When you are buying a stock that is widely followed, you are protected in some ways because so many people are watching the stock,'' said Jonathan Rosenthal, partner in the Los Angeles investment bank Saybrook Capital. ''You don't have that in these markets.''

Everyone loves a bargain.

But these may be some you're better off passing up.

------

Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org



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