No matter how you choose to invest, there is always some level of risk. In a savings account, your money is protected by federal deposit insurance, but the market decides how much your stocks are worth. And while investing in stocks can help you get rich, you can also lose money or not make any money at all.
But the question is, “Can a stock really lose its entire value?“
Here’s a straightforward answer to this question: YES.
Before this happens, there are often several signs that something is wrong. Still, it is possible for companies to go out of business and their stock to drop to zero.
Both new and experienced investors should think about whether or not a stock can lose all of its value. An investor can never do enough research and due diligence to avoid being caught off guard by a sudden drop in the price of an equity.
In this article, we’ll look at the things that could happen to bring about this worst-case scenario.
The Atrocious “B” Word
Investing in the stock market could be a fun adventure, but you have to be willing to take the good with the bad. All stocks have some level of risk, from the biggest blue chips to the smallest penny stocks.
As stockholders, the worst thing that could happen is a company declaring bankruptcy. Even though it’s much more likely that this will happen to a smaller, less well-known company, the forces of the Mother market mean that even the big guys can go bankrupt.
The most likely way for a stock to go to zero is for a company to stop paying its debts. As was already said, this can be caused by a loss of customers, problems with operations, bad management, or fraud.
Two Types Of Bankruptcy
Chapter 11 Bankruptcy: If a company files for Chapter 11 Bankruptcy, its stock can still trade. This is a very risky move, but it usually causes the stock price to drop sharply. Most of the time, a company in Chapter 11 nullifies its shares while it goes through a business reorganization.
Buying a stock in a Chapter 11 bankruptcy is about as risky as it gets because selling pressure often pushes such a stock toward zero. Also, even if a Chapter 11 company comes out of bankruptcy successfully, it usually issues new stock, making the certificates of the old shareholders worthless. To give the company a second chance, the shareholder would have to buy the new stock.
Chapter 7 Bankruptcy: When someone files for Chapter 7 Bankruptcy, on the other hand, the war stops right away. When a company stops doing business, its stock no longer trades on the market. In this case, the company’s creditors, or bondholders, will get the first choice of any money it can get by selling property or other assets.
Stockholders are at the back of the train and would have the last claim on any value left over after all debts are paid.
Establishing Stock Price And Bankruptcy
To help you better understand how a stock can lose all of its value, let’s look at how the price of a stock is set. In particular, the value of a stock is based on how well supply and demand work together. When there is a lot of demand for a stock, the price will go up. If not many people want a stock (if demand is low), the price will go down.
If the number of people who want to buy a stock drops by a lot, it will lose most or all of its value. The main thing that affects how much people want to buy a stock is how good the company is. If the company is strong on the inside, which means that it makes money, its stock is less likely to lose worth.
Other things besides supply and demand affect how well a business does. These have a lot to do with the basics and growth prospects of a company. As long as these things are good, the price of a stock tends to go up. If, on the other hand, a business can no longer make money, it may be forced out of business and have to file for bankruptcy.
When a business goes bankrupt, it doesn’t mean that everything it has is worthless. The company can still have assets that can be sold, a well-known brand, and skilled workers.
Because of this, companies often talk to their creditors to try and negotiate their liabilities and restructure the business to get out of bankruptcy. If the company can’t do this, it may have to have a “fire sale” to get money to pay back its debts (such as banks, bondholders, and preferred stockholders). Once these people have been paid back, only then can what’s left go to the common stockholders. The stock is worth nothing if there is nothing left.
What Happens If It Does Reach Zero?
When a company’s equity value falls to zero, it no longer has value. The stock is now worthless, no matter how it got there. Even the most generous investors won’t take a chance on this stock. At this point, there is nothing investors can do. A stock that loses all of its value is the worst case of the risks of investing in stocks. The only thing left for the investor to do is swallow their pride, learn from the mistake, and move on.
So, even if a stock loses all of its value, there may be something good about it. Investors can claim the capital loss on their taxes and use it to offset capital gains from other stock positions. This lowers the amount of tax they have to pay.
Not everything has to be lost. If this does happen, we’ll take the lesson to heart: don’t put too many eggs in stocks with a high chance of going bankrupt so you don’t end up with a bunch of squawking geese on your front porch.
Implications On Long Positions And Short Positions
If a stock loses all of its value, it will affect a long position differently than a short position.
Whoever has a long position (owns the stock) hopes that the investment will go up in value. If the price drops to zero, the investor loses all of their money, also called return: -100%.
On the other hand, a stock’s value going to zero is the best thing that could happen to an investor with a short position in the stock. Since the stock is worthless, the investor with a short position doesn’t have to repurchase the shares and give them back to the lender (usually a broker).
This means that the short position gets a return of 100%, which is good. Keep in mind that the advanced practice of short-selling securities is probably not a good idea if you are not sure if a stock can lose all of its value. Short selling is a gamble, and the risk of losing money on a short position is much higher than on a long position.
Can A Zero-Valued Stock Rebound?
Ultimately, the people who trade on the stock market decide how much a stock is worth. It comes down to supply and demand, just like the price of any other asset. If people want a stock a lot, the price will go up, but if they don’t want it, the price will go down. The price traders are willing to pay for a stock is based on how much they think the company will be worth in the future.
