While regular value investing involves dealing with a wide number of unknowns, distressed securities represent particularly complex situations.
Because most investors are unwilling to put in the time and effort involved with analysing such securities; for some, the opportunities are plentiful in this realm.
Three Reasons for financial distress
- operating issues,
- legal issues, and/or
- financial issues.
- continue to pay obligations,
- attempt to convert obligations into less stringent obligations (e.g. get debt holders to accept preferred stock), or
- default and declare bankruptcy.
- understand how other stakeholders will react to such situations, and
- understand the power that various stakeholders have (for example, one third of a stakeholder groups constitutes a blocking group, and can use this to further that stakeholder group's interests).
- Assets should be valued so that the size of the pie can be estimated.
- Obligations should then be subtracted from this amount.
- This task is much more difficult than it appears, however.
- For a distressed company, asset values are usually a moving target, and getting a handle on their value can be difficult.
- Furthermore, off-balance sheet liabilities must also be considered.