The Zacks Rank is designed to show investors which stocks are seeing increases in earnings estimates. If you
believe that earnings drive stock performance, then this is a very powerful tool. Some investors skin the cat a
different way, choosing to wait until a stock is facing complete disaster
or at least something very close to that.
The old saying goes when there is blood in the streets, buy and for the investors that do this on a regular basis,
it can be a profitable trade. At the same time, it can also very dangerous to the average investor that cannot
watch the market all day.
When a company faces disaster, shareholders tend to shoot first and ask questions later. The preservation of
capital is often more important than excess returns. That partially explains why stocks that fall a significant
amount tend to see a bounce from the bottom, or a dead cat bounce.
But what about the companies that have seen that big drop, that massive rush to the exits? What happens to those
stocks and who is there to buy the shares that a few hours ago, a few days ago, no one wanted? Well the distressed
investor is there to take absorb the risk.
Lower Price, Less Risk?
Before we get to a few examples of distressed investing, we need to make sure we understand that the risk / reward
ratio has changed drastically. As the price falls, one may think the risk decreases, but in fact it does not. The
risk is actually a little greater in that distressed investors may not come to the recuse. Remember, at any time,
the max loss in a stock is 100% of the invested capital. That is true of a stock bought at $70, $7 or $0.07.
The reward scenario, however, has likely changed drastically. Investors that had weak hands sold the stock as it
was falling, but there is still a chance for a significant recovery. Often times that huge dip leads to a dead cat
bounce, but distressed investors are usually in it for more than a quick trade. They want to see the stock return
back to levels it saw before it was distressed.
If The Shorts Fit
Personally, I love the title I gave this section even if others do not. American Apparel (APP) is one of the stocks that fits the distressed investing
molds. The company makes and sells branded fashion apparel, or what I call shorts, t-shirts and other casual wear
items. The company, like several other retailers has been under substantial pressure over the last several quarters
as discretionary spending is down and production costs continue to remain high.
APP also has some unique challenges and competencies that drew distressed investor Michael Bigger and his Bigger
Capital Management to buy more than 3.27M shares of APP stock. The story line for APP became even more interesting
when the Board of Directors removed CEO Dov Charney, potentially putting the company in an insolvent position.
In removing the CEO, the board put the company into what appeared to be a change of control situation that would
make it default on certain debts it carried. The stock was trading around $0.60 at the time of the announcement,
and just the headlines would make most battle hardened investors run for cover
and that is just what the they did
in selling stock pushing it down back neat 52 week lows.
Since that time, new funding and a call for the removal of the board has produced gains of more than 100% as the
stock has traded over $1.20. The free advertising from this event alone has put a very bright spotlight on the
stock, company, products and management. That type of equation seems to be very positive for 3 out of the 4
Beyond the press of this event, we need to look APP on its own merits. It is a smaller market cap company, with a
valuation of right around $200M. That might keep a lot of investors out of it due to size, the $1.14 closing price
on Friday might also keep some investors out. Interestingly, APP is a Zacks Rank #3 (Hold) but the fear of default
on its debt has not really made it a huge short. Approximately 17% of the float is short, and while total shares
short has increased from 13.1M at the end of May to 15.4M at the end of June, that is only about 7.5% of the total
number of shares outstanding.
Crumbs From The Table
The cupcake bubble certainly hasnt fully popped, the other day I saw a food truck in Chicagos loop offering a $6
red velvet cupcake. The thought of me chomping down on such a delight brought a Homer Simpson-esque droll to my
mouth. Then when I saw the bite size cupcake I became as like Dr.
Bruce Banner and almost turned as green as a pistachio cupcake. Clearly, the bubble has not burst on this
Crumbs recently close its 70
or so cupcake shops across the country and an already distressed investment became a very distressed investment.
The stock has been moving lower for some time, but when shares started trading for around a nickel, most people
believed that the business was dead and it was time to move on.
Distressed investors, however, decided that it was time to take a closer look at the business of cupcakes and how
this specific investment was performing. On July 10, the stock was trading at about $0.03 after the company
announced it was filing bankruptcy. Then someone started buying shares around that level and before you knew it,
the stock was trading at $0.40 at which point I tweeted:
And on StockTwits:
Guess there are a few more $CRMB left on the table... I bought a few thousand here.— Brian
Bolan (@bbolan1) Jul.
10 at 12:13 PM
Following those tweets, CRMBQ ran higher still to more than $0.76 the following day. This is nothing short of a
meteoric rise! But like most meteors, it has since come back to earth, losing most of the initial gain.
I spoke with Michael Bigger about distressed investing for some deep insight from someone that has done this
successfully. I came away with a few tips that apply to both distressed investing as well as "normal" investing.
Mr. Bigger noted that distressed investing is basically a binary event, with the result being bankruptcy or a big
payout. When a stock gets on a distressed investors radar screen, as Mr. Bigger put it, "you already have a lot of
the problem resolved." This means that all the bad news is already baked into the stock and the other issues are
This next idea is easily the most important. Mr. Bigger says that "whether you have the money or not, would you be
proud of owning all of the asset." As much as that is a great way for distressed investors to think, it is very
applicable to everyday investing. Too often investments become (losing) trades because there was no real pride of
ownership in the stock.
A great example of the pride of ownership would be a stock like Tesla (TSLA - Free Report) , as holding this stock can make the investor feel like
they are part of an automotive revolution. But it is also important to not let emotion rule your decision making.
At the end of the day, investing is about making money with your money be it distressed or not.
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Brian Bolan is a Stock Strategist
Zacks.com. He is the Editor in charge of the Zacks Home Run Investor
service, a Buy and Hold service where he recommends the
stocks in the portfolio.