What is a ‘Bad’ Company?
When a company is unable to return the debts that they have taken, due to any of the reasons mentioned below, then it is declared to be bankrupt and termed as a ‘bad’ company.
- Bad economy
- Mismanagement of funds or
- Any other such reasons
By investing in such companies, investors can make a lot of money. But, there has to be a good amount of research done on the fundamentals before investing in it. When invested in the right ‘bad’ company, you can get good returns by purchasing its stocks, provided you are confident that there will be a turn-around.
When to invest in bad stocks?
The economy is such that any good company could go into bankruptcy. So, it is essential to do research on the fundamentals of the company, which are:
- Business potential
- Credit line
The price of a company’s stock is not just based on demand and supply, but also on these fundamentals; a wise investor picks up shares based on it and not on the actual price of the stock. If a company with good fundamentals goes bankrupt, then it is a good time to buy its stocks as there is a higher possibility for the company to make a turn-around sooner or later.
When a company becomes bankrupt, the owners are at the losing end, the creditors scramble to get back their money and the shareholders want to sell all their stocks. Some of them are even sold in secondary markets and this is the time when the market is flooded with the shares of a bankrupt company. The prices of these shares will be very low, and that is the time you should take advantage and invest. The key is to hold on to it long enough till the value rises again. It is highly essential that you do the due diligence before buying such shares; learn more about the reason for the company’s loss-making else you might end up on the wrong side of the coin!
What are the risks?
Every investment has a risk attached to it and so does investing in bankrupt companies!
- Reorganization can be a challenge:Not every company is successful in the reorganization as they could at times be unable to clear all the debts. There are many recent examples where the original investors or banks of the bankrupt company have no desire to keep the stock in the restructured company. In such cases, lenders may not get repaid even the principal, leave alone the interest! Moreover, the reorganization plan is such that it does not treat the cause and thus the bankruptcy court may reject the plea.
- Volatility of Stocks:Another significant risk to consider is that the price of stocks of bad companies often keeps fluctuating more than other stocks. You should be ready to accept that there is a considerable risk of losing all the money you invested when you buy such stocks, especially if the plan is to invest for a short term.
You need to do a lot of due diligence, and proper research as the restructuring plan for the bankrupt company may not get through due to many reasons.
Bankruptcy is both good and bad for the economy. It provides a great investment opportunity for you to invest the capital in revitalizing the company to make it strong and at the same time, it can help by making you rich; all this is possible only if the investment is done after a thorough research!