The Motley Fool: Steer clear of troubled firms

Considering investing in a company in or near bankruptcy? Think twice.

A company files for Chapter 11 bankruptcy protection (usually extremely reluctantly) when it’s having trouble paying its bills. Under Chapter 11, it can continue to operate while it reorganizes. With any luck, it will get its act together and become stronger than before, as Texaco did in the late 1980s. If the company cannot generate enough capital to pay off its creditors, it will likely end up in Chapter 7 – getting liquidated.

In Chapter 11, the company remains in possession of its assets, under the administration of a court-appointed trustee. It must file a plan of reorganization with the bankruptcy court. If any creditors are to receive less than full value for their claims, they’ll have the right to vote on their acceptance. After the vote, the court can accept or reject the plan. So the company has some flexibility, but if it tries to deal too harshly with various creditors, its plan isn’t likely to be approved.

In most cases, the company will have to sell off assets to raise money to pay creditors. The proceeds usually won’t be enough to pay all prioritized creditors in full, so the creditors might accept a reduced amount of money, some stock in the reorganized company, or a combination of the two.

If you notice much attention being paid to creditors and little to shareholders, you’re not imagining things. Holders of common stock in the company are not anywhere near the front of the line. They’re behind debt holders, merchant creditors, trustees, employees, the IRS and even preferred shareholders. Even the insiders’ stock stakes usually end up worthless.

Some companies in Chapter 11 do emerge from it and survive (such as Western Union and Delta Airlines) – but many don’t (think Enron, Worldcom and Polaroid). And with those that do, it’s rare for shareholders to benefit, as they’re last in line to receive something from the bankruptcy. Steer clear of companies in trouble.

Ask the Fool

Q: How can you figure out if a company pays a dividend? – B.A., Tampa, Fla.

A: You can call the company and ask, or look it up online or in newspaper stock listings. Instead of the dividend itself, many stock listings include the dividend yield, which is the percentage of the current stock price being paid out annually in dividends. If there’s a yield, it means there’s a dividend.

To figure out the dividend from the yield, just take the yield and multiply it by the stock price. Let’s say that Farm Dogs Inc. (ticker: BINGO) is trading at $80 per share and has a yield of 2 percent (which is 0.02). Multiply 0.02 by 80 and you’ll get 1.60, meaning that the company is currently paying out $1.60 each year in dividends per share. (Companies often pay dividends quarterly, so this would be $0.40 per quarter.)

If you’re looking for promising stocks that pay significant dividends, grab a free trial of our Motley Fool Income Investor newsletter at www.incomeinvestor.fool.com.

My dumbest investment

After getting burned by the recent Internet bubble, I had the opportunity to invest in a stock right after its IPO (initial public offering). It was supposed to open at around $85 but instead opened around $100. It was hyped to be the next big thing, with astronomical price potential, but I was not going to get fooled again. So I passed. The stock: Google. Enough said. – Marjory, Florida

The Fool Responds: Steering clear was actually a reasonable thing to do. Initial public offerings can be very volatile, with their prices often hyped to steep levels, only to sink in relatively short order once the shares begin trading. You can usually find other bargains among companies that have been public for many years – you don’t need IPOs to make you rich. That said, Google has done very well for many investors, at least the early ones. It surpassed $700 per share in late 2007, though it has shed several hundred dollars per share in 2008. Some might want to take a closer look now, and wait for possibly lower prices.

The Motley Fool take

It’s a big deal, as transactions in the forest-products industry go. International Paper (NYSE: IP) plans to shell out about $6 billion in cash to Weyerhaeuser (NYSE: WY) in exchange for the latter’s packaging, containerboard and recycling businesses.

But since the buyer will realize an estimated $1.4 billion income tax benefit from the deal, the company’s net outlay for the acquired assets actually will be closer to $4.6 billion. The transaction will likely close by the third quarter of the year.

Weyerhaeuser has been trimming ancillary businesses lately, attempting to concentrate on its wood products, real estate and homebuilding core. In 2007, for instance, it sold its fine-paper business to Canada’s Domtar (NYSE: UFS).

And for its part, International Paper has also undergone a substantial makeover. Three years ago, the company began selling its wood products, timberlands and coated-paper businesses. In the process, it slashed its net debt by almost two-thirds. It is now concentrating on packaging and uncoated paper. Through its deal with Weyerhaeuser, the company will roughly double the amount of revenue generated from packaging.