Editor's note: This Weekend Edition, we're taking a break from our usual fare to share an essay by Stansberry's Credit Opportunities editor Mike DiBiase. Most recently published in the DailyWealth on July 6, 2019, Mike's piece details how he makes easy, stock-like returns... without taking stock-like risks.
Have you ever heard someone talk about "picking up nickels in front of a steamroller"?...
This old Wall Street adage simply refers to trying to earn small returns while taking on the risk of large catastrophic losses. The strategy works as long as you don't slip.
But you'll never get rich doing this... And eventually, you'll get crushed.
Today, I will share a strategy that is the complete opposite... It's like picking up $100 bills in front of an asphalt truck. And as you'll see, with this strategy, you could potentially earn significant returns while taking on far less risk...
Most investors want to stay as far away as possible from dying companies...
The idea of investing in companies spiraling toward bankruptcy scares them. Investing your hard-earned money in businesses headed to zero seems like a sure-fire way to get wiped out.
That's understandable. But the thing is, fears of pending doom can sometimes create opportunities for savvy investors to make huge returns before these companies go bankrupt.
To be clear, this isn't a strategy where you profit as a company's share price falls – like shorting the stock or buying put options. With those strategies, it's critical to get the timing right. And they expose you to large losses if the stock suddenly rises.
With the strategy I'll share today, you're making an actual investment in a company...
You aren't taking on any additional risk if the stock's price rises. In fact, a rising stock price only reduces your risk.
And no, I'm not talking about investing in "penny stocks" with the hope that they'll double from $0.30 per share to $0.60 per share. Investing in them is nothing more than gambling. These stocks could just as easily go all the way to zero.
In fact, you might have realized by now that this strategy doesn't have anything to do with investing in stocks at all...
I'm talking about investing in a company's debt...
More specifically, I'm talking about buying corporate bonds issued by companies headed for bankruptcy.
To be clear, you don't want to touch these companies' stocks. Their best days are long behind them. While you could make some money if investors react favorably to any glimmer of good news, sending the stock higher for a brief period of time, it's generally a losing move.
It's not a matter of if, but when, these companies will go belly-up.
But here's the important thing to remember...
Just because a company is headed for bankruptcy doesn't necessarily mean its bonds aren't safe. You can earn massive, safe returns when you invest in the debt of dying companies.
This is because bond investing is a lot different from stock investing...
Most investors have never thought about investing in corporate bonds. They believe stocks are the only way to invest in companies. That's what Wall Street wants you to think...
They save their best investments for their wealthiest clients. Have you ever had a stockbroker try to sell you a corporate bond? I doubt it. They make massive profits on the commissions from investors buying and selling stocks.
But bonds are actually much safer and easier to understand. And unlike stocks, when investing in bonds, you don't have to love a company or think it has a rosy future. You don't need to come up with estimates of what you think the company is worth. All you need to understand is whether you'll get paid what you are contractually owed.
Unlike equity, bonds are legal obligations for the company to pay you... You'll receive interest payments (called "coupons") every six months. And you'll get paid $1,000 in principal (called the bond's "par value") when the bond matures at some point in the future.
If the company doesn't pay all of the interest and principal as it comes due, it'll go bankrupt. As we like to say, bonds are binary... you either get paid in full or you don’t. There are no other possibilities. And unlike stockholders, even in bankruptcies, bondholders usually end up recovering at least part of their investments.
That's why investing in bonds is far safer than investing in stocks. And it's why I urge you to consider investing in bonds today if you haven't done it before.
Our monthly newsletter Stansberry's Credit Opportunities is devoted to finding the best opportunities in corporate bonds. My colleague Bill McGilton and I spend a lot of time studying and writing about debt. Bill is a former corporate lawyer who analyzes all of the important bond documents. We recommend safe bonds – those that we research thoroughly and determine will pay us in full and on time – that deliver equity-like returns.
But why, you might wonder, would we ever suggest you invest in the debt of a company headed for bankruptcy? The answer is simple...
Companies headed for bankruptcy are great places to find the best bond opportunities...
Here's why...
Most investors do a poor job of evaluating heavily indebted companies. Their sentiment about the companies tends to go from one extreme to another...
They either assume a company is completely safe and pile into its stock and bonds, or they assume it's completely toxic and sell anything associated with the company.
And this overall sentiment can flip from one extreme to the other quickly... When investors turn on a company, they turn fast and hard. This "love 'em or hate 'em" mentality creates wild swings in both its stock and bond prices. And that creates mispricings...
Some of the bonds issued by these troubled companies can trade for far less than the $1,000 par value. They might trade for $500, for example. But remember, bondholders are still entitled to collect $1,000 at maturity – plus all of the interest payments along the way.
The only thing that matters in bond investing is whether the bond you are buying is safe to own...
You can be extremely pessimistic about the company that issued the bond... while being comfortable owning one of its bonds. If the company that issued the bond goes out of business a few years after you've been paid, who cares? Your money will be elsewhere by that point.
Now, I need to be clear: You don't want to buy just any bond of a company headed for bankruptcy. Not every bond is safe. But the opposite is true also... Not every bond is toxic.
You need to understand a company's debt schedule and borrowing capacity to figure out which ones are safe. And some bonds become far too cheap for the level of risk.
That's because most companies don't go bankrupt overnight. They die slow, painful deaths...
These bankruptcies often take much longer than investors expect.
New management is often brought in to run the troubled company. This new leadership implements its "turnaround" plan, trying to resuscitate the dying business. It cuts costs, sells off old assets and product lines, and invests in new technologies and businesses.
These folks have a lot invested in the stock, so they do everything they can to bring the company back to life. No one wants to see a company go bankrupt under his watch.
The new management "sells" its strategy to new investors. The company's stock price often temporarily recovers. And as long as the business is still remotely profitable, banks and other creditors freely lend their capital to fund management's new strategies.
It can take years before investors realize the turnaround isn't working. Meanwhile, the dying company continues to make its interest payments and meet its debt obligations.
And that's how savvy investors can earn huge returns. Let me give you an example...
You could have nearly doubled your money investing in a bond issued by now-bankrupt retailer Bon-Ton Stores...
The department-store chain filed for bankruptcy on February 4, 2018. The bankruptcy surprised no one. What surprised nearly everyone, however, was how long it took to happen...
In 2011 – seven years earlier – everyone knew Bon-Ton would go bankrupt. The "retail apocalypse" was sweeping the country. Tens of thousands of brick-and-mortar stores started closing. Bon-Ton's sales had already fallen 15% from a few years earlier, and the company was no longer profitable.
Investors priced Bon-Ton's stock for bankruptcy. The company's market cap dropped to less than $50 million, and it was sitting on a pile of debt that totaled nearly $1 billion.
Bond investors gave up, too... In January 2012, you could have bought Bon-Ton's only outstanding bond for around $540 – a substantial discount to par value ($1,000).
But if you did your homework, you would have known this bond was safe to own...
Smart investors knew it was too early for Bon-Ton to go bankrupt. Although the company was posting accounting losses, it was still generating around $100 million in annual "cash profits" – the cash it generated from its business.
The company could easily afford its interest payments. And it owed only a small amount of debt before the bond came due a few years later. On top of that, Bon-Ton's banks were willing to lend it another $450 million on its revolving credit facility.
Investors who bought the bond in January 2012 stood to earn nearly 50% on their investment if Bon-Ton survived another two years and paid it off. As it turns out, folks who bought Bon-Ton's bond didn't have to wait that long...
Just a few months later, Bon-Ton issued a new $330 million bond maturing in five years. The cash infusion temporarily restored investors' confidence in the company. By the end of 2012, the bond that investors bought for around $540 traded for more than its $1,000 par value.
Investors who sold the bond when it returned above par earned a 92% return in less than a year.
The following year, Bon-Ton paid off the bond early – and in full.
As I've explained, the stigma of impending bankruptcies can often create opportunities like this...
In the June 2019 issue of Stansberry's Credit Opportunities, Bill and I recommended a bond with a similar setup. But it was even safer than the Bon-Ton bond just mentioned.
It was issued by a retailer that was certain to meet the same fate as Bon-Ton... JC Penney. But we didn’t believe it would go bankrupt for at least another three years.
The company still generated a ton of cash... could easily afford its interest payments... and had little debt maturing over the next few years. The bond we recommended matured in less than one year, and JC Penney should have been able to pay off the bond with just the cash it generated from its business.
The market realized its mistake and the bond’s price shot up by the end of 2019. We sold it for close to par value and booked a 22% gain in just five months.
We see setups like this all the time. Investors assume that dying businesses aren’t worthy of investment and treat them as toxic waste. But most companies die slowly. They continue to pay their employees and vendors. And they continue to make their interest and debt payments as they come due.
Smart investors can take advantage and earn huge, stock-like returns with much safer corporate bonds.
Regards,
Mike DiBiase
Editor's note: If you're still skeptical about bonds, you don't have to take our word for it. One of Mike's paid-up subscribers went on camera to explain how this investing strategy helped him retire at age 52... and why he never has to worry about his money in any market environment. What's more, Mike says the recent market sell-off has created a fresh opportunity to make potential triple-digit gains through bonds alone. Click here to get all the details.
