These days, a lot of stocks have fallen more than 70-80% and their share prices have breached below $5 or even much lower. With this kind of price, it’s much better to treat them as call options as long term investments. However, there are subtle differences on why some of these stocks fell to this price range.
1) Heavy debt wrecking havoc
Las Vegas Sands, once the crown jewel of all casino stocks, is the typical example of this. Traded as high as $120/share, touched below $5/share on Oct 28 and Oct 29. This is an incredible story, since as we all know, the house always win, but apparently not in the case when the house is built on debt and bad times hit it hard. Given time and lower debt structure, there is no doubt that LVS would regain its glory, but now the whole franchise is in question. However, if you believe that the company can cross this chasm, this is a great call option, already illustrated by a subsequent short squeeze which took it to over $15/share after it traded below $5, although now it had backed down to close at 7.03 on Nov 7th.
2) Deteriorating or simply lack of fundamentals compounded with debt structure
Once the largest EDA companies, Cadence Design Systems, falls into this category. Traded as high as $24/share in 2007, its share price is now $4. Cadence has almost all the problems a company can have: questionable accounting, bloated structure, declining market share, just to name a few. Normally balance sheet analysis does not come into question, but in this credit environment, it comes under great scrutiny. While the company has sufficient cash, $250 million convertible note is due in 2011, and another $250 million convertible note is due in 2013. The combination of declining revenue, questionable accouting, and having <5 yrs convertible notes on the book, will likely keep the share prices in the single digits for some time even if credit market improves.
3) Disappearing earnings and cash flow
Trident Microsystems, with ~$200 million liqudation value but only $96 million in market capitalization, falls into this category. The main problem with companies like Trident is the disappearance of its revenue, along with earnings and cash flow. Nonetheless, the balance sheet is intact, and it can still survive quite a long time even under this credit environment. If one has faith in the company’s direction and its future, I believe this kind of company is suitable enough as long term call options.
However, remember, while these < $5 stocks can have great potential, the nature of call options is that you can lose all your money on it.
