Identifying and Profiting off Companies Emerging from Bankruptcyby Tom Murcko
Once a company emerges from bankruptcy, holders of the company's debt usually don't get paid off in cash (the company usually doesn't have much cash), but rather mostly newly issued bonds or common stock. So new shareholders and bondholders are mostly the company's former creditors. Just like with spinoffs and merger securities, most will sell because they wanted cash, not company shares, all along. You need to be selective, because the average company coming out of bankruptcy underperforms the market, for various reasons: the original factors causing the company to go bankrupt might still exist; the company probably doesn't have much capital; if the company's business had been easy to sell, the creditors probably would've forced the sale during bankruptcy. On the other hand, the very worst situations usually don't make it out of bankruptcy, and Wall Street usually ignores such situations because they don't have a financial incentive to research or promote them. Try to focus on companies that have some of the following: companies with a strong market niche, brand, franchise, or industry position; companies that went bankrupt due to a short-term problem such as overleverage; companies that went bankrupt to protect themselves from potentially huge liabilities on a discontinued or isolated product line; companies for which customers won't care that the company had gone bankrupt.