Automakers and Investing Risk

We highlight General Motors Corp. (GM) and Ford Motor Co. (F - Analyst Report).

Today's news about the automakers shows the inherent risk of investing.

First, there is the demise and restructuring of Chrysler. Chrysler will file for Chapter 11 bankruptcy protection. As a result, Cerberus Capital Management will take a substantial loss. Some hedge funds, unwilling to admit the magnitude of their mistakes, will also incur losses.

Fiat will, in turn, will form an alliance with a stake in the restructured Chrysler. Dealerships will be closed and auto-parts supplier contracts will probably be revised.

Secondly, a group of General Motors (GM) bondholders are making a counter-offer. The proposal gives the UAW a 41% equity stake, a 51% stake to bondholders and 1% to current shareholders. In blunt terms, if you own GM stock, this proposal essentially wipes out the value of your holdings.

Capitalism works by punishing those who make mistakes. Furthermore, stocks generate higher long-term returns by exposing investors to greater risk.

Both of these factors are at play today and show the inherent risk of investing. If you buy shares in a struggling company, you are likely to lose money. At the same time, bondholders get priority in bankruptcy. Shareholders might get the earnings, but it's the debtors who get the cash.

It's something to think about since Ford (F - Analyst Report) is jumping today. After all, a messy General Motors bankruptcy could take the stock right back down.

There is nothing wrong with making speculative trades if you have money you are completely willing to lose. However, with so many fundamentally stable companies to choose from, and a wealth of information to help you make the right picks, it just doesn't make sense to take a large gamble on companies with big problems.

Cerberus is learning this lesson with Chrysler, and many individual investors are about to learn that lesson with GM.

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