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    Three Penny Stocks you Should Avoid
    March 16, 2011  PSW Staff
    Bankruptcy is without a doubt the most disturbing word in the language of investing, and for
    proper reason. Equity investors know, or soon will, that an investment in a company that goes
    bankrupt means you lose all of your money. You could even lose more than you invested if
    you are using margin. Creditors, which include bond holders, get any assets that are
    available, and shareholders are almost always left with nothing. Only those that bet against
    the company before the bankruptcy, either by shorting the stock or by other means, as well as
    a few strategic bond traders, will make a profit. Shorting a stock before the company goes
    bankrupt almost always yields an immediate 80% return with a high probability of that return
    eventually going to 100%.

    Do not think it is a quick death either, in fact, it is quite the contrary. The equity that is left gets
    chopped up and immediately delisted to the Pink Sheets, where a fifth letter 'Q' is added to
    the symbol. Often, the stock is organized into a new entity entirely, or a holding company. The
    best time for a long investor to get out of the stock is always as soon as possible. When
    World Com went under, investors who sold earlier in the day made out a lot better than those
    who sold at any time after that. Some enterprising investors may try to sell the stock right
    away, then buy some back at the bottom and hope for the dead cat bounce that usually
    follows. This is a precise game where victory is breaking even, and defeat is losing twice as
    much as you would have in the first place.

    These stocks bounce around quite
    a bit, and occasionally see
    significant pops, but the end game
    is always zero. The stock will wither
    away slowly down to a penny, then
    below a penny, then below a tenth
    of a penny until it either flat-lines or
    gets pulled entirely. Take a look at
    Circuit City (CCTYQ.PK). The
    company was bought by a hedge
    fund and was turned private. All
    bricks and mortar locations were
    closed, but the online store
    remained. The stock continues to
    trade on the Pink Sheets, but has
    lost almost all life. Take a look at
    Mesa Airlines (MESAQ.PK). The
    stock trickled down slowly into sub
    penny land, then the last wave of
    selling hit just before the company
    announced it was emerging from
    bankruptcy, going private, and
    canceling all outstanding shares.

    Nevertheless, a significant number of traders flock to bankruptcy issues. Experienced high
    risk day traders find enormous short-term percentage swings. Some traders specialize in
    bankruptcy issues. For the average investor or trader, however, these stocks may be a
    mistake. Some may simply be fascinated that such a well-known name can be trading for
    pennies a share. Others may be drawn to the heavy volume and the large percentage
    swings. Either way, trading bankruptcy issues requires absolute precision, experience,
    intestinal fortitude and luck. The vast majority of traders and investors, even those not
    adverse to significant risk, will certainly find better investments elsewhere. Here are a few
    issues garnering quite a bit of attention right now, despite being wholly worthless.

    Borders Group Inc. (BGPIQ.PK)

    Even before becoming the nations ninth largest company to file bankruptcy on February 16,
    Borders was headed in a downward spiral. The stock was already down 75% on the year
    after another quarter of declining revenues and unsustainable losses. The company has
    been able to secure half a billion dollars in financing from GE (GE) Capital, whereby they can
    continue to own and operate some stores and sell others, but if they do not meet the terms of
    the financing, GE will take possession. Although the balance sheet is bad and getting worse,
    that is not where the main problem is. Companies like Amazon (AMZN) and Wal-Mart (WMT)
    online have eaten away at Borders' business model. It has failed to build up its online
    division, and even failed in an E-Reader attempt. It is simply too late, and Borders is too far
    behind to catch up now. BGPIQ is in the early life stage of a bankruptcy, so this soon-to-be
    dead fish will continue flopping around while Barnes and Noble (BKS) tries to fillet it. Whats
    left over in the end will probably be snatched up by a hedge fund.

    Blockbuster Inc. (BLOAQ.PK, BLOBQ.PK)

    Blockbuster is a bit further along in the process having filed for bankruptcy protection in
    September of last year, and the hedge funds are already circling. This business model is
    further along in the process of deterioration, as well. Blockbuster survived and even thrived
    for a little bit after Hollywood video and the Movie Gallery consolidated and failed together,
    similar to what Barnes and Noble may experience. The company had a couple of ideas in the
    mid 2000's, including Blockbuster by Mail to compete with Netflix (NFLX), and the elimination
    of late fees. Blockbuster tried to buy Hollywood video in 2004 as it was failing, and even
    considered a bid for Circuit City in 2008. In 2009, blockbuster began rolling the kiosks out in
    an attempt to compete with the already established Redbox by Coinstar (CSTR). The
    company went on to accumulate over a billion dollars in debt, and was forced to dismantle.
    Some positive action in the stock over the past few months should not be mistaken as any
    materially positive news for shareholders. The stock is simply trading on momentum related
    news of more favorable conditions for debt holders than were previously expected. This
    means that the stock is trading on a false premise; there is still no indication that stock
    holders will get anything at all in the end.

    Nortel Networks Corp. (NRTLQ.PK)

    This stock is the furthest down the slide of these three issues, and a purchase now will likely
    yield an immediate and total loss. To see exactly what you are getting for your two cents, lets
    take a look at the financial statements. The company had over 10 billion dollars in revenue for
    all of 2008. During the most recently reported quarter ending December 31, 2010, revenues
    were $28 million, and the cost of revenue was $40 million. Overall, the company lost more
    than $2 billion in that quarter alone, and Nortel finished the year with $4.5 billion in quickly
    depreciating assets, and over $11.5 billion in quickly appreciating liabilities. Not only is this
    stock completely worthless, it is starting to get hard to get in and out of.
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