Why has bankrupt J.C. Penney (OTCMKTS:JCPNQ) been such a “hot stock” as of late? Blame it on FOMO, momentum trading, and other factors independent of fundamentals. The department store chain’s stock rallied 95.9% alone on June 8! And that’s after shares bounced up 54.8% on the prior trading day. But, shares of what used to be known as JCP stock (prior to its Chapter 11 filing) are not the only bankrupt or near-bankrupt name to perform so well in recent days.
Traders and speculators fortuitous to ride this counter-intuitive wave of bankruptcy rallies have made what looks like “easy money.” At the end of the day, however, this looks more like gambling than investing. Why? When it comes to Chapter 11 bankruptcy, the odds aren’t on your side.
Simply put, Chapter 11 bankruptcy usually means that the common stock winds up becoming worthless. Ownership is handed over to the company’s creditors, and the common stock is cancelled. Sure, sometimes a bankruptcy ends up leaving shareholders with some equity. But even then, that’s after extreme shareholder dilution, as creditors receive newly-issued shares to settle outstanding debts.
In short, it’s not wise to dive into bankrupt names like JCP stock. But the consequences of a Chapter 11 filing aren’t the only reasons to completely avoid this retail dinosaur’s shares.
Why J.C. Penney Isn’t Coming Back From This
Besides FOMO and momentum-based trading strategies, some may be buying JCP stock thinking the underlying business will bounce back, leaving some value on the table for shareholders.
Not so fast! Even beyond the obvious “bankrupt status” of the company, the retailer’s underlying business is a dead man walking. As I discussed on May 29, think of this company in the same vein as Sears (OTCMKTS:SHLDQ).
At one point, both retailers were where American households bought their clothes, appliances, electronics, etc. But in the past few decades, they’ve seen their competitive edge completely erode.
Sure, there may be a place in the retail ecosystem for an “old school” department store. Yet, that niche can be more than filled by names like Macy’s (NYSE:M), and Nordstrom (NYSE:JWN). Granted, both aren’t doing so hot right now, with the novel coronavirus lockdowns affecting operations. But, as we enter recovery mode, both have a shot at bouncing back. J.C. Penney? Not so much.
Like what we’ve seen with Sears, this bankrupt retailer has already begun liquidation sales at 136 stores, becoming a mere shell of what it once was. More importantly, today’s shareholders won’t be along for the ride much longer. Whatever the outcome in bankruptcy court, chances are the common stock trading today will head to zero once it’s all over.
Buying Bankrupt Stocks Is Like Playing With Fire
I get that some investors want to take a gamble with JCP stock and other bankrupt names. After seeing shares more than double in just a few days, I agree FOMO may override caution. But, as I discussed above, there’s no rational reason to invest in companies that have filed for Chapter 11.
The most likely outcome is that you get wiped out. This could happen if the company cancels its common stock and hands over equity to the creditors. Or, like in the case of Sears, a separate entity acquires the operating assets. In that scenario, the proceeds are distributed to creditors, and shareholders get nothing. This may wind up happening, given news of private equity firm Sycamore Partners’ interest in buying the company out of bankruptcy.
Alternatively, the company could liquidate completely, distribute proceeds to creditors, and again, leave shareholders with zero. No matter how you cut it, there’s likely no underlying value left for shareholders.
Shares Are Going to Zero
If you think you’re going to get rich buying J.C. Penney stock, think again. As I’ve previously said, don’t take recent trading action to mean shares are on the rebound. The same situation that played out with Sears stock post-bankruptcy will play out here. Shares rallied several times while the company was in Chapter 11. But today, the worthless common stock trades for pennies.
In short, it’s still game over for JCP stock, so steer clear, and avoid at all costs.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.