Ask Money

Buy GM

Chris Farrell Apr 3, 2009

Question: I have a little bit of money that I wouldn’t mind speculating with. (Nice way to say gambling) But I don’t want to just throw it away. For that I can go to the casino. I was actually thinking of buying GM stock. It’s certainly cheap enough. But I wonder about bankruptcy and how that affects stock owners. I understand bankruptcy is not the same as ceasing to exist, indeed if I understand it correctly it is one of the first steps to ensure it continues to exist, but how do stock holders fare in the process? Do they face the same kinds of risk that bondholders and creditors do? Thanks for taking the time. Michael, Harshaw, WI

Answer: Putting money into the battered, beleaguered automaker is speculating at the extreme. As you well know, this is making a bet on a wing and a prayer, pulling the slots on the corner of Wall Street and Broad.

On October 1, 2007 GM’s stock price peaked at $42.64 a share. Today it trades a few pennies over $2.00 a share. Here’s a chart of GM’s stock price over the last two years from Marketwatch.com.

The risk of GM declaring bankruptcy is very high. If GM does go into Chapter 11 bankruptcy existing shareholders will probably be wiped out. That’s what typically happens with Chapter 11.

Creditors usually come out much better. Depending on the terms of the loan contract, bondholders, bankers and other creditors have far better financial protections. Still, odds are that many creditors won’t recover their whole investment in GM. Creditors will negotiate for a big chunk of the new equity in a reorganized GM. These former-debtors turned equity-holders will own much of the company when it emerges from bankruptcy.

If you want to speculate in the stock market how about putting the money into a broad-based low-fee equity index fund. I know it isn’t exciting. But if the recent market rebound–the best four weeks since 1933–is for real you’ll pocket a nice gain. Of course, it’s impossible to know if the market has hit bottom or whether the gain is nothing more than a traditional sucker’s rally in a bear market. If it’s the latter, at least you’ll own a stake in real companies while you wait for the recovery.

Of course, if you bet on GM and it avoids bankruptcy its stock should sizzle, at least or awhile. But I’d bet on the market and not a fallen giant.

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