Every investor who buys individual stock inevitably will come up with a dud that loses money. But it can get worse. A stock can wipe out completely: Not only does it fall in value, it takes all of the investor's money down the drain—going to zero—often as a result of bankruptcy. This is nothing less than a debacle for the average investor who buys stocks with the expectation that they will go up in value.
However, some investors actually profit when prices decline. But most short sellers, as these players are known, are professionals who have a bigger appetite for risk.
What happens if a stock goes to zero?
Unfortunately, when a stock's price falls to zero, a shareholder's holdings become worthless. Yet, even before a stock reaches the bottom, major stock exchanges create thresholds that delist shares once they fall below specific price values. The New York Stock exchange (NYSE), for instance, will remove stocks if the share price remains below a dollar for 30 consecutive days.
A delisted stock loses the privilege of being on popular exchanges, and no buying or selling can occur through typical methods. Instead, the stock is now considered over-the-counter (OTC) and appears on the OTC bulletin board, also known as “pink sheets” for bargain trading by speculators on alternative exchanges.
Going to zero seems pretty low, but an investor might ask: Can stocks go negative? Can you lose more than you invest in stocks? The answer to both is, “No,” just as long as you are not borrowing money on margin from your broker to make the purchases. If a stock goes to zero, you have no money to repay the loan.
The long and short of it for investors
Investing in stocks always carries risk and the stock market can be volatile, leaving some stocks to fall precipitously and lose all their value. Financial gains or losses of a stock reaching zero depend on whether an investor is in a long- or short-term position.
The average investor is usually devastated watching a stock price plummet to zero, but the opposite is true for the short-term investor trying to sell stocks short.
In short sales, investors borrow shares in a company and sell them, betting the stock will fall, so they can buy the stock for a lower price, return the loan, and keep the difference as a profit. Shorting stocks is risky because with a $10 stock, for example, the maximum you can lose in a decline is $10. But if you’re short, and the stock goes to $100, you lose $90. Hedge fund Melvin Capital closed after it shorted the shares of AMC Entertainment and other “meme” stocks, only to see them rocket, causing billions in losses.
Whether long or short, it’s essential to understand the forces of supply and demand that determine a stock’s value and the circumstances that can lead to a stock price falling to zero.
What determines a stock’s price?
The fundamentals of supply and demand make stock prices go up and down. If demand is high, people buy stocks, causing prices to climb, but if demand is low, they will sell, and prices will fall, sometimes at dramatic speed.
Companies sustain demand for their shares by running dependable, profitable businesses. But that’s much more difficult than it might appear, especially during hard economic times. Most start-up companies fail, and no established company posts rising earnings every quarter, forever.
Reasons for loss of demand and a stock losing value:
- Slowing growth in revenue or earnings, or worse yet, losses.
- A perception that the shares are overvalued, especially with speculative growth companies. The dot-com bubble is an example.
- Negative investor sentiment derived from leadership shakeups, legal issues, or a management scandal.
Who buys stocks that go to zero?
When a stock reaches zero or dips to a level that disqualifies it from being listed on a major exchange, its shares move to over-the-counter markets, aptly named because trades are made between two parties directly, without a central exchange. Examples are OTCQX, OTCQB, and OTC Pink marketplaces. Buyers are often scarce in OTC markets, and prices can swing wildly on just a few trades.
These volatile markets remain popular with speculators hoping to make quick profits on companies that others have left for dead—known as penny stocks. Penny stocks are shares in companies that trade for less than $5. They are often very illiquid, meaning they don’t trade often. As volume declines, fewer traders are willing to take a chance on companies trading for a few dollars, or worse, pennies and the stocks can often go to zero for lack of interest.
Examples of stocks that went to zero
- Enron. Enron was a large energy company in the 1990s that hid huge losses and toxic assets of no value behind creative accounting practices. It was trading as high as $90.75 in 2000. When it began reporting massive losses, analysts and investors became suspicious of the accounting practices it used to value its assets and dumped the stock. Enron was trading at $0.26 just before it declared bankruptcy in December 2001.
- WorldCom. This telecommunications company perpetrated the largest accounting fraud in U.S history, causing one of the biggest bankruptcies. WorldCom inflated net income and cash flow by recording expenses as investments to conceal its losses. In 2001, it reported $1.3 billion in profits even though it was losing money. Its stock price fell from over $60 to less than $1 before declaring bankruptcy in 2002.
How does a company become worthless?
When a company can no longer operate profitably, it may be forced to declare bankruptcy. At this point, the company is essentially worthless until it decides to restructure or fold altogether. These companies have two choices:
- Chapter 11 bankruptcy, also known as a reorganization. Companies choose this route when they work with creditors to renegotiate their debts in hopes of returning to profitability. Unfortunately, stockholders are often at the end of the line for compensation and see very little return. Very often, a bankrupt company will cancel its stock, making investor shares worthless.
- Chapter 7 or liquidation. If the situation is too dire for restructuring, a company is forced to sell off its assets to repay creditors such as banks, bondholders, and maybe, preferred stockholders. Holders of common stock almost always get nothing.
Preventing a share price from going to zero
Companies have options when their shares are in freefall. They can take steps to avoid being relegated to the OTC market, where volume dries up, and greater losses are often assured. Here are some options:
- Reverse splits. A company may initiate a reverse stock split to decrease the number of outstanding shares and increase the price per share. As a result, shareholders lose a certain number of shares, but the value of each share goes up, raising the stock price for the company. For example, in a 1:2 reverse stock split, a shareholder holding 100 common shares would now have 50, but each share's value would double.
- Share buybacks. If company managers believe a stock is dramatically undervalued for no reason, they might repurchase some of the shares at the reduced price and then reissue them once the price has rebounded. Buybacks are increasingly popular in equity markets. Investors should be on the lookout for companies with buyback plans in place because—while it’s no guarantee—such demand can lift share prices.
- Improve financial performance. If a company increases sales and revenues without increasing costs, it will increase its return on investment (ROI), making it more attractive to investors. Companies with slumping share prices will often bring in turnaround experts paid in shares and have huge incentives to fix operations. Peloton, for example, brought in Barry McCarthy, the former chief financial officer at Spotify and Netflix, to stem losses and streamline operations in early 2022.
The bottom line
The price of any stock can fall rapidly and even plummet to zero, usually when a company goes bankrupt. Whether this proves positive or negative depends on the position an investor holds. An investor in a long position can lose everything, while someone holding a short position can benefit greatly.
Suffering a “zero” isn’t always possible to avoid, but investors may consider monitoring the company’s spending, revenue, and profit growth. Remember: When an investor buys a stock, and it goes up, they’re being paid for taking a risk. The risk is that the stock can go to zero, and that’s a very real possibility. Stocks don’t come with warranties.