As the stock market hits new highs in July, investors are riding a wave of optimism, closely tracking climbing indexes. Yet, beneath this bullish surface, some publicly traded companies are becoming bankruptcy risk stocks as they’re grappling with the stark reality of financial distress.

Of course, investing in stocks of companies that have filed for bankruptcy carries notable risks. While there are scenarios where strategic asset sales or restructuring might present short-term gains, such investments are often perilous. The likelihood of losing the entire investment is high, as bankruptcy proceedings can leave shareholders with nothing.

In this article, I will present three publicly traded companies that have become bankruptcy risk stocks. Whether these companies failed to adapt to changing times, leading to deteriorating financials, or were crippled by unsustainable debt loads exacerbated by rising interest rates, their investment cases have gone down the drain. Although these stocks might still have some residual value at their current levels, they are best avoided due to the substantial bankruptcy risks involved.

Chicken Soup for the Soul Entertainment (CSSE)

Chicken Soup for the Soul Entertainment (NASDAQ:CSSE) operated a diversified entertainment business model, producing, acquiring, and distributing video content via its own streaming platforms and syndication deals. The company leveraged its well-known brand to create inspirational and family-friendly content, aiming to carve a niche in the crowded streaming market.

However, Chicken Soup’s strategy faced considerable challenges, leading to its eventual bankruptcy. The company sustained unsustainable losses due to high operational costs and intense competition from major streaming giants. To cover these losses and fund its growth, the company engaged in massively dilutive stock issuances, which deteriorated shareholder value. Its share count leaped from 11.5 million in 2017 to over 32 million at the end of Q1.

Chicken Soup accumulated a massive debt position, standing at $579.3 million at the end of Q1, primarily from expansions and acquisitions. This debt became increasingly burdensome as rising interest rates exacerbated the interest expense, further weakening the company’s financial health. After failing to pay its employees, Chicken Soup filed for bankruptcy just over a week ago.

eFFECTOR Therapeutics (EFTR)

eFFECTOR Therapeutics (NASDAQ:EFTR) was a biotechnology company focused on the development of novel therapies for cancer patients by targeting the process of protein translation. Their innovative approach aimed to disrupt cancer cell growth and proliferation, positioned eFFECTOR as a potential leader in oncology therapeutics.

Despite its somewhat promising scientific foundation, including innovative approaches to disrupt cancer cell growth, the company faced insurmountable challenges that ultimately led to its downfall. In April, eFFECTOR Therapeutics announced its decision to halt the development of Tomivosertib for treating frontline non-small cell lung cancer. This hard decision came after disappointing results from a mid-stage trial, where the therapy failed to meet its endpoints.

This setback affected eFFECTOR’s pipeline hugely, as Tomivosertib was a key candidate in its portfolio. Ultimately, no bullish reason to keep eFFECTOR’s investment case promising remained, leading to the downfall of its stock price. With expenses continuing to pile up, bankruptcy was inevitable.

Delta Apparel (DLAPQ)

The final company on my list of bankruptcy risk stocks is Delta Apparel (OTCMKTS:DLAPQ). A small-cap stock even before its financial distress set in, Delta Apparel was known for manufacturing and selling a wide range of activewear, lifestyle, and outdoor apparel via various brands and distribution channels. Some of its largest customers included Walmart (NYSE:WMT), Target (NYSE:TGT), Nike (NYSE:NIKE).

Despite its established presence in the industry, the company struggled with declining profitability due to intense competition and shifting consumer preferences. As a result, Delta Apparel’s revenue growth stagnated, putting pressure on its margins and, hence, bottom line.

Compounding these issues was Delta Apparel’s substantial debt position relative to its size, which peaked at $252.2 million last year. The company went into a rising interest rate environment when servicing this debt became increasingly expensive. Also, instead of deleveraging, Delta Apparel had previously engaged in share repurchases, which further strained its financial flexibility and ability to manage its debt effectively. At $0.07, Delta stock is best avoided despite any potential fluctuations in its favor, as it faces delisting.

On the date of publication, Nikolaos Sismanis did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

On the date of publication, the responsible editor did not have (either directly or
indirectly) any positions in the securities mentioned in this article.