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The argument in favor of buying Kodak stock goes something like this: Now that Kodak has filed for bankruptcy, its stock trades for about 30 cents; but since it traded for more than $30 just a few years ago, doesn’t that mean it has to be cheap? Unfortunately, there are two major fallacies with this argument.
First, as we have pointed out many times in the past, the stocks of companies in Chapter 11 almost never do well. Under the rules of bankruptcy, all the creditors who come ahead of the stockholders, such as banks, bondholders, suppliers, etc., must be paid off in full before shareholders get anything. In almost every bankruptcy, there is not enough value left over after other creditors have been satisfied to give anything to the stockholders.
Therefore, the stock in a chapter 11 case almost always ends up worthless or nearly worthless. (Sometimes, the old stockholders will get some very out-of-the-money warrants or a few shares of heavily diluted new stock, but those typically have little or no value.)
The other fallacy is to try to estimate the future price of the stock based on where it traded in the past. A stock’s value is determined solely by the company’s current and future assets and prospects, and its past trading price is irrelevant. Unfortunately, Kodak’s future looks much less illustrious than its past.