As you know, car rental agency Hertz recently filed for Chapter 11 bankruptcy.
The news did not really surprise me. After all, I reviewed the stock in March and advised my readers to stay away due to the company’s worryingly high debt burden.
Predictably, once the bankrupty news broke out, the stock price crashed 80%, dropping from $2.84 to $0.56 in just four days. In normal circumstances, that would be the end of the story.
But we are not in normal circumstances.
In a remarkable turnaround, Hertz received approval to sell up to $1 billion of common stock in a last-ditch effort to raise the necessary liquidities to survive the coronavirus crisis and possibly avoid bankruptcy. The news sent the stock flying more than 800% from $0.56 to $5.53 in less than two weeks.
Hertz’s rationale for emitting the new shares rests on one premise: that tourism and business travel picks up and generates enough cash flow to avoid bankruptcy. If the gamble turns sour, and travel volumes remain too low to generate significant revenues, the company will proceed with the scheduled bankruptcy and all shares will become worthless.
This is a risky proposition that investors should really think through before buying shares.
The SEC filing asking to issue the common stock warns that “a process of reorganization under chapter 11 of title 11 of the Bankruptcy Code has caused and may continue to cause our common stock to decrease in value, or may render our common stock worthless“. The filing also mentions that Hertz has appealed the NYSE’s delisting notice but “cannot provide any assurance as to the ultimate resolution of the appeal“.
“This is not investing. It is gambling“, said Nancy Tengler, chief investment officer at Laffer Tengler Investments. Jim Cramer concurred: “You may think a stock like Hertz or Chesapeake looks like a steal at these levels, but the only people being robbed here are you the buyers. It doesn’t matter how little you pay for a stock, when it goes to zero, you lose everything“.
Why are people rushing to buy the stock
of a company filing for bankruptcy?
In my (humble) opinion, it’s a combination of three things: the rise of do-it-yourself investing, people treating the stock market like a casino, and the Greater Fool Theory.
The investment world is changing.
Back in the day, people interested in the stock market had to go through specialized institutions which charged you hefty fees for the privilege of investing. These barriers to entry meant investing was a carefully planned process and the vast majority of people would think twice before YOLOing their savings into highly speculative gambles.
Over the past decade, the emergence of online brokers has made investing much more accessible. These new platforms provide anyone with a tax number the possibility to sign up without minimum investment amounts (they’ll even gift you a free stock), trade commission-free or at very low cost, buy fractional shares of any stock, and use in-app portfolio management tools.
In sum, investing is easier than ever.
As a result, retail investors disilusioned with both the low interest rates of savings accounts and the high fees charged by investment professionals are understandably attracted to cheap and user friendly online brokerage apps such as Robinhood and M1 Finance. Today, traditional investment firms are losing business as do-it-yourself investors take charge of their portfolios.
Admittedly, I am one of these investors myself.
I have never used a bank or a brokerage firm to buy stocks and I don’t plan on ever doing so. Let me be clear: the fact that new investors can manage their own finances and network with like minded people to share investment ideas is a great thing.
But it’s not without risks.
The negative aspect of cheap and easy investing is the inevitable drift towards impulse buying and get rich quick mentalities.
American society is addicted to shopping and an estimated 20 million Americans are compulsive shoppers. On top of that, an additional 10 million Americans have some form of gambling addiction. Researchers believe that compulsive shopping and gambling have similar impulses to drug and alcohol addiction. That means almost 1/10 Americans are addicted to the dopamine rush of spending money recklessly. The rise of online shopping and gambling websites is making matters worse, and the number of people falling victim to these addictions is on the rise.
In some ways, irresponsible investing can become a form of both compulsive shopping and gambling, and online brokers can become the Amazons and Bellagios of the stock market.
In the post-COVID world where people are hesitant to return to physical venues, online everything is booming. Amazon sold $10K worth of goods per second during the confinement and posted record first quarter sales of $75.4 billion. Similarly, online gambling providers say they saw a spike in volume during the shutdowns.
It’s thus entirely plausible that a portion of shopping and gambling addicts have turned to the stock market for their dose of dopamine. In their May earnings release, Robinhood revealed its user count increased to 13 million, up from 10 million since the end of last year and Google searches for the app have exploded to record highs. While Robinhood is at the forefront of public discussion, the same holds true for virtually all online brokers.
Is the Greater Fool Theory driving the market?
Since technology makes it so easy to buy and sell stocks, impulsive people can quickly forget that investing requires research and patience. They let their emotions get the best of them and start treating the stock market like a casino.
They see stock prices rising and want in on the action. They have the Fear Of Missing Out (FOMO) on huge, potentially life-changing gains. I need this stock because it will make me rich. If I miss out, I’m not going to be rich. I need to buy this stock now. It’s going up and up. Surely, it can’t go down. I’m all in. Oh no! I bought the peak and the price is crashing. Why did I do that?
I’ve had FOMO before and it’s very difficult to ignore.
FOMO doesn’t care about a stock’s fundamentals. It sees a high flying asset or a potential ten-bagger and wants to buy it with the sole intention of selling it to someone else for a higher price. This is called the Greater Fool Theory: buying an asset irrespective of its intrinsic value in the hopes of selling it to an even greater fool who will pay an even higher price for it.
The best example is the Dutch Tulip Mania of the 17th Century, where single tulip bulbs sold for more than 10 times the annual income of a skilled craftsworker. Why did people pay so much for a flower? Because they were convinced they would be able to sell it to someone else for even more money. The problem is that people eventually realized the absurdity of paying insane prices for flowers, and the entire tulip market crashed.
This not investing – it is pure speculation.
In the midst of all this madness, Jim Cramer said that Wall Street pros are clearly taking advantage of all the aforementioned trends by hyping up underperforming stocks during premarket trading hours, only to dump the shares on retail traders at the open. Presumably, Cramer knows what he’s talking about since he openly admitted to manipulating the market in his favor using similar tactics in the past.
What does all this have to with Hertz?
Most rational investors know that Hertz has a very slim chance of surviving this crisis.
The company relies on packed airports for business and even when they are, it struggles to compete with the rise of ridesharing. The fact that the aviation industry’s return to normalcy is expected to be long and slow, short and medium term prospects are not at all encouraging. Trump’s proposed $4,000 tax credit for domestic travel may help, but it’s no guarantee that people will spend their money renting Hertz vehicles.
In the best case scenario where Hertz’s stock offering raises $1 billion, it’s still wholly insufficient to pay off both daily operating expenses and the near $4 billion of net debt that will remain after all assets are liquidated. Years of poor financial management – which culminated in a balance sheet loaded with more than $20 billion debt – is finally catching up with the company.
As mentioned in the introduction of this article, Hertz’s SEC filing made abundantly clear that the stock may ultimately end up worthless. Shareholders are the first to lose out during bankruptcy filings as debts are paid out to lawyers, suppliers, and creditors before stock holders are even considered.
If even a high-risk tolerant billionaire investor with decades of experience is throwing in the towel, what makes retail investors think they have a chance?
They are hoping they will be able to flip the shares to a greater fool.
The problem is that some fool will be stuck holding the bag.
Don’t let it be you.
I’m not a financial advisor but I highly advise you stay away from this dumpster fire of a stock and invest your money in a solif ETF or reliable, blue chip stocks.
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DISCLAIMER: This is not financial advice. Always do your own research before investing.