Can a Stock Lose All Its Value?

Can a stock lose its value?

The answer to this question, in theory at least, is a pretty straightforward: Yes.

Stocks are able to lose all their value in the market, and have done so before, especially in the case of a bankruptcy. Even if a company does go bankrupt, in reality shareholders often do receive some residual payment back, but this is usually just pennies on the dollar. This fact should not scare you off from investing in stocks, or investing in general. However, we would be lying if we claimed that stocks carry no risk (although some, of course, carry more than others). Read on to see how a stock's price can get wrecked and approach zero.

Determining Stock Price and Bankruptcy

To help you understand why a stock can lose all its value, we should review how the stock price is determined. Specifically, the value of a stock is determined by the basic relationship between supply and demand. If a lot of people want a stock (demand is high), then the price will rise. If a lot of people don't want a stock (demand is low), then the price will fall.

If a stock's demand sinks dramatically, it will lose much (if not all) of its value. The main factor determining the demand for a stock is the quality of the company itself. If the company is fundamentally strong, that is, if it is generating positive income, its stock is less likely to lose value.

So, although stocks carry some risk, it would not be accurate to say that a loss in a stock's value is completely arbitrary. There are other factors that drive supply and demand for companies. These have a lot to do with a company's fundamentals and growth outlook. As long as these are favorable and positive, a stock's price tends to rise. If, however, a company can no longer operate profitably, there is a chance that it will be forced out of business and declare bankruptcy.

When a company declares bankruptcy, it doesn't automatically mean that is absolutely worthless. The company can still hold assets that could be sold, brand recognition, and skilled employees. As a result, companies will often negotiate with their creditors to renegotiate their debts and restructure the company to emerge from bankruptcy. If the company is unable to achieve this, it may be forced to sell off its assets in a fire sale to repay creditors (such as banks, bondholders, and preferred stockholders). Only once these parties have been repaid can common stockholders receive any compensation based on what's left. If there is nothing left, the stock is worth zero.

Impact on Long and Short Positions

The effects of a stock losing all its value will be different for a long position than for a short position. Someone holding a long position (owns the stock) is, of course, hoping the investment will appreciate. A drop in price to zero means the investor loses his or her entire investment: a return of -100%.

Conversely, a complete loss in a stock's value is the best possible scenario for an investor holding a short position in the stock. Because the stock is worthless, the investor holding a short position does not have to buy back the shares and return them to the lender (usually a broker), which means the short position gains a 100% return. Bear in mind that if you are uncertain about whether a stock can lose all its value, it is probably not advisable to engage in the advanced practice of short selling securities. Short selling is a speculative strategy and the downside risk of a short position is much greater than that of a long position.

To summarize, yes, a stock can lose its entire value. However, depending on the investor's position, the drop to worthlessness can be either good (short positions) or bad (long positions).

Real-World Example of a Stock Losing All Its Value

Sometimes a company will be forced into bankruptcy and its stock fall to zero as the result of an accounting scandal or fraud. Take the famous case of Enron, a large and influential energy and trading company in the 1990s. By the early 2000s, the company was riding high and its stock was seeing all-time highs.

What people didn't know yet, however, was that Enron was using accounting tricks to hide massive losses and holdings of toxic assets. By 2001, analysts and investors began to question Enron's mark-to-market accounting practices and became suspicious of the company's earnings. In 2001, the company started to report massive quarterly losses, which quickly spiraled out of control.

At Enron’s peak, its shares were worth $90.75 in 2000; just prior to declaring bankruptcy on Dec. 2, 2001, they were trading at just $0.26.