What Happens When a Stock Goes To Zero? The main driver of share price fluctuation is the connection between supply and demand. If demand is high, prices rise. If demand is low, prices fall.
Moreover, if demand for a stock drops off completely, its price will rush downwards in an increasingly dramatic fashion.
But is it actually possible for a stock to go to zero?
The short answer is pretty simple: Yes.
What’s interesting, however, are the reasons behind how and why this calamitous event even happens at all.
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What Is A Stock Really Worth?
While it’s easy to say that supply and demand ultimately determine a share’s price in the market, what makes a company more or less attractive to a potential investor?
In essence, a business is rated on its ability to generate meaningful profits for its stakeholders.
This doesn’t mean it has to be profitable right now to be valuable; demand can still be high so long as there’s the expectation of positive income somewhere down the line.
In fact, that’s why the growth outlook for a company is so important – and why negative or positive sentiment about its future performance can move the needle on its current price so much.
That’s not to say, however, that the present state of operations can be ignored entirely. A firm that cannot function at a profitable level is one that is in serious trouble.
When it does become obvious that a company has failed – and its fundamentals cannot support a viable business – bankruptcy is often the next step.
Bankruptcy usually ensues when a company can no longer service its outstanding debt. The bankruptcy process is intended to relieve a debtor from his or her obligations, and provide creditors a remedy and opportunity for repayment.
There are different types of bankruptcy, each of which can precipitate radically different outcomes for those who own stock in a business.
For instance, if a company files for Chapter 11 bankruptcy, there is a possibility that, once creditors have been compensated, the enterprise may continue to trade in some form.
On the other hand, Chapter 7 bankruptcy involves a firm’s nonexempt assets being sold, with the business effectively liquidated thereafter.
In this case, creditors who have issued secured debt – such as banks and other financial institutions – can hope to be reimbursed from any proceeds of those sales. If there is no money remaining after this has happened – which is normally the case – common stockholders will be left owning shares that are, for all intents and purposes, worthless.
What Are The Chances That A Stock Goes To Zero?
Although the nightmare scenario of a Chapter 7 bankruptcy is real, the likelihood of a publicly-traded company going bust overnight is small. Indeed, as mentioned, a company would usually have to become insolvent for this to happen.
However, stock exchanges can step in and delist the shares of a company that fall below a certain limit, meaning that investors can lose everything even if a stock doesn’t literally go to zero.
There have been some high-profile examples of businesses that have gone bankrupt, demonstrating that the risk is not merely theoretical.
In the US, energy firm Enron had to file for bankruptcy following the revelation of its dubious accounting procedures, while in Britain, Debenhams, a London Stock Exchange-listed department store founded in 1778, also failed after racking up unsustainable debts.
It’s not just stocks that can go the zero either. Cryptocurrencies are vulnerable to excessive price shock too.
Take the case of Terra Luna, a digital asset that was part of the Terra blockchain network. The token was trading at an all-time high of $119 in April 2022, while Terra’s associated fiat-pegged stablecoin, TerraUSD, was the third largest algorithmic stablecoin on the market at the time.
However, only a month later, the entire ecosystem was wiped out. The project lost $45 billion in little more than a week, with investors and onlookers alike astonished at the speed at which the project had collapsed. In fact, between May 12 and May 14, Terra Luna went from $1.06 to just $0.000116 – a loss in value of more than 99.999%.
The Implications For Long And Short Traders
When a stock approaches zero, the impact of such a price change will be felt differently depending on the particular investor’s perspective.
For example, those holding long positions will hope for the price to rise, enabling them, as owners of the stock, to sell their shares for a profit later on. However, if the stock declines in value to zero, the owner is exposed to a loss of 100% on their initial investment.
The opposite situation is true for those holding short positions. In this case, if a stock drops to zero, the investor is no longer required to buy back the stock as it has become, basically, worthless. In this arrangement, the investor would realize a gain of 100%.
While these gains and losses mirror each other when a stock goes to zero, the risk profile of holding a stock either long or short does not. This is because short selling actually carries with it an unlimited downside, since, hypothetically at least, shares can increase indefinitely in value.
Wrap-up: What Happens When a Stock Goes To Zero?
It’s a rarity when it happens, but stocks can and do fall to zero. Not even the biggest and oldest companies are immune from bankruptcy and failure either.
When a stock does become worthless, it doesn’t always follow that investors will lose everything. There are some occasions when shareholders may be entitled to some kind of compensation, such as when a firm is liquidated after having been wound up due to insolvency.
Paradoxically, when a stock is heading for zero, it may also see a spike in its trading volumes too. This is what happened in the case of Terra Luna, with some investors hoping its huge price losses would reverse, while others shorted the coin in anticipation that it would just fall further.
In the end, investors can protect themselves by having a diversified and well-weighted portfolio, one that features businesses from a wide variety of industries that are at different stages in their lifecycle and development.
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