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Jun 2020

Corporate Bankruptcies are Upon Us

By Kevin Mahoney, CFP®, CIMA®

J. Crew, Nieman Marcus, and JC Penny – mainstays of American culture and commerce – now bankrupt. Seeing these headlines can be alarming, but what does it mean for investors?

Naturally, it depends.

If an investor adopts a concentrated strategy in which a limited number of direct investments are held, corporate bankruptcies could mean real trouble. For example, we had a client hire us with a portfolio that was equally and fully invested in eight stocks. Just one bankruptcy among those eight could wipe out over 12% of that portfolio. Another investor had 100% of his $5 million portfolio in one stock that quickly became $500,000, and all he wanted was a do over. By contrast, and granted, it is an anomaly, Warren Buffet has always run a concentrated portfolio, so it can work if disaster is avoided.

If an investor adopts a diversified strategy in which thousands of investments are held via mutual funds or exchange traded funds, bankruptcies are moot – a single bankruptcy is not felt or noticed. For this reason, we heavily favor the diversified strategy.

Being positioned to capture equity returns, and being diversified to avoid the impact of bankruptcies becomes even more appealing when we consider how common it is for companies to fail. One way to measure this is by how many stocks have negative lifetime returns. Professor Hendrik Bessembinder of the W.P. Carey School of Business at Arizona State University published a paper(1) in 2018 in which he studied the lifetime returns of the over 25,000 stocks that have made up the Center for Research in Security Pricing (CRSP) database from 1926 – 2016. In this study he found that more than half of the stocks had negative lifetime returns. A diversified investor not only avoided being devastated by any one of those negative lifetime returns, but enjoyed a 9.9% average annual return from 1926 – March of 2020 (S&P 500).

Another way to look at this is to measure the number of actual bankruptcies. Keep in mind that not all bankruptcies end in total loss – many companies are saved along the way or have valuable assets or business lines that are purchased by other companies. That said, while statistics on private companies are hard to come by, according to the American Bankruptcy Institute, there have been more than 6,000 commercial bankruptcies in the US per year over the last 10 years, so it is no anomaly. We can also get a sense of the commonness of bankruptcy simply by taking a trip down memory lane with the below list of household names who all filed for bankruptcy.

In closing, we wish you proper diversification, and therefore, little worry about the bankruptcies that will continue to color the newswires.

(1)May 2018 “Do Stocks Outperform Treasury Bills?” By Hendrick Bessembinder of the W.P. Carey School of Business, Arizona State University

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