Editor's note: Most folks assume a bankrupt company is a bad business. But according to our colleague Gabe Marshank, if you know what to look for, these investments can actually lead to unbelievable gains. In this piece, Gabe explains the profits that are possible from post-bankruptcy companies – and what questions you should ask to find the potential winners among them...
One word makes investors flinch...
It conjures up images of CEOs in handcuffs, empty office buildings, and headlines about shareholder wipeouts.
The truth is, this word – "bankrupt" – isn't always the end of the story.
Sometimes, it's the beginning of an incredible investment opportunity.
That's something I've learned in more than two decades as a professional investor. In fact, buying stocks coming out of bankruptcy has led to some of my biggest winners under Wall Street legends like David Einhorn, Steve Cohen, and Leon Cooperman.
Not every post-bankruptcy stock is a home run, of course. But when you get it right, the upside can be unbelievable...
Most people assume a bankrupt company is a bad company. But what actually sends companies into Chapter 11 isn't always poor operations... It's almost always bad balance sheets.
Even more to the point, it's less about having too much debt and more about being unable to pay it off or refinance.
In short, bankruptcy isn't a question of solvency, but of liquidity. A company can carry plenty of debt, as long as it can afford it.
Sometimes, a business has a ton of debt, but market conditions allow it to keep running and get new loans without issue. Other times, even a great business can run into a situation where funding dries up and the company is in trouble.
The good news is, bankruptcy clears that debt. The process wipes out shareholders – and make no mistake, it is painful. But as a result, the original debtholders take over... And in their hands, the company's underlying assets survive.
Often, the assets themselves are perfectly fine. Once the debt gets cleared out, new investors can buy those assets at a massive discount.
Two Post-Bankruptcy Success Stories
Let me walk you through a couple of examples...
One of the most famous post-bankruptcy successes of all time is Marvel Entertainment. (Yes, that Marvel – the company behind Iron Man, Captain America, and Spider-Man.)
Marvel was once a big comic book company. But in the early 1990s, the comic book market crashed. People stopped buying expensive collectible comics, and Marvel's revenue dried up.
In an attempt to get things back on track, Marvel acquired trading-card company Fleer and took a large stake in a toy company. But those moves didn't pay off... Suddenly, Marvel found itself with a shrinking core business and a big debt load that it couldn't pay back.
In late 1996, Marvel filed for Chapter 11 bankruptcy protection, which allowed it to reorganize and shed some of its debt. At its low in 2000, the stock traded around $0.85 a share.
New management refocused on Marvel's valuable intellectual property. Instead of licensing its characters out, Marvel made a big bet on itself and decided to produce its own movies.
Marvel Studios went on to produce box-office blockbusters like Iron Man and The Avengers. And in 2009, entertainment juggernaut Disney (DIS) bought Marvel for $4.2 billion, or roughly $54 per share... handing shareholders a 6,000%-plus return.
Sometimes, when the world gives up on a company, that's your chance to buy the same business – or an even better one – at a tiny fraction of the price.
It was the same story with amusement-park chain Six Flags Entertainment (FUN)...
Six Flags had borrowed money aggressively to buy new parks and expand quickly, especially during the late 1990s and 2000s. Management believed buying more parks and adding attractions would bring more visitors – and more profits.
The company kept piling on debt to fuel this growth. But the returns from its new investments weren't enough to cover its borrowing costs.
When the financial crisis hit in 2008, consumer spending dried up, and so did Six Flags' borrowing power. By 2009, Six Flags was sitting on around $2.7 billion in debt and was facing a $400 million payment it couldn't refinance.
The company couldn't keep up any longer. It filed for Chapter 11 bankruptcy in June 2009. The parks stayed open during the bankruptcy process, but the stock was delisted.
In bankruptcy, Six Flags worked out a deal called a "debt-for-equity swap." That meant some of its lenders agreed to cancel a portion of the company's debt in exchange for a larger ownership stake.
The new owners cut costs and focused on improving the experience at existing parks instead of wild expansion.
Bankruptcy allowed Six Flags to clear much of its debt, get new leadership, and focus on running a better business. The company emerged from bankruptcy in May 2010. Shareholders who bought then made more than 600% over the next seven years...
These opportunities exist because most investors can't – or won't – do the work.
A company that has just emerged from bankruptcy is often unloved and mispriced. The old shareholders are gone, and the new stock often has little to no Wall Street coverage. The investment community is confused and skeptical... And that's a big advantage for you.
I like playing games where the odds are tilted in my favor. Post-bankruptcy stocks are one of those rare corners of the market.
These companies have already been through the wringer. By the time they emerge from bankruptcy, they've often shed underperforming divisions and gained eager new management. Most importantly, they have a cleaner balance sheet, giving you a much more attractive entry point.
That doesn't mean you should buy every company that comes out of Chapter 11. You first have to ask yourself if the business is sound. You don't want to own a melting ice cube. But as we've seen, plenty of great companies go through the bankruptcy process.
If a company has high-quality assets, the next step is to ask yourself, "Why should I own this stock? What has changed? What's the upside, and what are the risks?"
In my brand-new publication, Market Maven, I spend a lot of time thinking about those questions... and recommending stocks when we think they can go up 300% to 500% in the next three to five years.
We look for clean balance sheets, solid businesses, signs that supply and demand are out of whack, and a clear reason why the stock is mispriced.
Sometimes, the reason is that nobody else is paying attention... And that's just fine by me. These stocks, when chosen carefully, are misunderstood, unloved, and often spectacularly undervalued.
Bankruptcy isn't always a death sentence. Sometimes, it's a fresh start... for the company and for your portfolio.
Regards,
Gabe Marshank
Editor's note: Gabe has contributed to no fewer than 18 triple-digit winners for Stansberry Research subscribers – and he's known as our firm's "secret weapon." On October 29, he's stepping forward for the first time to share the keys to his virtually unrivaled track record... and reveal a recommendation from his brand-new portfolio that could make 25 times your money.