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Can A Stock Go Negative?

TABLE OF CONTENTS

Can A Stock Go Negative?

Can A Stock Go Negative?

Vantage Updated Updated Fri, 2022 August 19 05:44

There are numerous professional stock traders who have made a name for themselves in the dynamic stock market. However, it is essential to keep in mind that the stock market is also prone to numerous factors that influence stock prices, which makes traders wonder, can a stock go negative?

The simple answer is, no.

Even if stock prices fluctuate or fall drastically, they can never attain a negative value (less than zero). While stock values cannot attain a negative value, book values can go negative. This means that investors can lose more than the capital invested and even end up in debt. This typically happens when companies go bankrupt[1].

If a company lacks funds to pay off its creditors, stockholders earn zero compensation, and their stock may become worthless. In some cases, investors end up losing their entire investment.

Key Points

  • Stock prices can drop dramatically but cannot go below zero; however, investors can lose their entire investment, especially if a company goes bankrupt.
  • Penny stocks and shares from poorly managed companies carry high risks, potentially leading to significant losses or even a fall to zero value.
  • Short selling and margin trading expose investors to losses that can exceed their original investment, especially if the stock value unexpectedly increases.

High-risk stocks

Investing in stocks is a risky venture. Stocks such as penny stocks and poorly managed companies are of particularly high risk. While investments in such stocks may skyrocket, they can plummet just as quickly[2].

  • Penny stocks

Penny stocks are shares that have extremely low prices and are subject to high volatility. These stocks usually trade on the pink sheet system or OTC markets, but the issuing companies have extremely low profits. Penny stocks are also prone to scams and their stock values are likely to fall close to zero, or even reach zero.

  • Stocks from companies with poor business models

If the company issuing stocks is poorly managed, its stock value can drip to zero or near-zero levels. It is extremely essential for investors to research and understand a company’s business model before investing in it.

However, stock prices rarely fall to zero even when companies go bankrupt, because the stocks still retain some value. Low-trading shares are typically delisted by stock exchanges before prices get to near-zero levels.

Factors that determine the value of stocks 

A company’s earnings, supply and demand, and investor perception can all influence the prices of stocks. When a company has turned consistent profits in previous years, investors have a positive perception towards it and the stock can be in demand driving up stock prices. However, if investors perceive the stock value to be low, prices can fall. 

When the number of investors looking to buy a particular stock is higher than those looking to sell, stock prices rise, and vice versa. The company’s earning is also a major factor that affects a company’s value. If a company turns in profits consistently, it has a positive future outlook and shares can appreciate. However, if profits fall short, share prices drop [3]. 

Can losses exceed your investment?

Going short or trading on margin exposes you to high risk and you can easily lose more than your entire investment. For example, with short selling, you can lose money when stocks appreciate.

When trading on margin, traders buy stocks using money borrowed from brokers to increase their capital size and leverage their trades. Therefore, losses will be multiplied by the leverage and you can lose your own money[4].

When going short, you can lose more money than you had invested if you go short on a stock and it unexpectedly appreciates by more than 100%. This typically happens when investors take short positions on stocks from companies that are performing poorly. Short selling relies on the premise that prices will fall. Therefore, if stock prices rise, you may end up losing more money than you had invested because you have to repay what you’d borrowed.

What happens if stocks go negative? 

While we’ve established that the actual price of a stock can’t go below zero, it’s still important to address the hypothetical scenario. If a stock were to go negative, it would imply that shareholders owe money to the company or its creditors, which is not how stock investments work. 

Shareholder liability 

One of the fundamental principles of stock investing is that shareholders have limited liability. This means that, at most, an investor can lose the amount they’ve invested. They aren’t liable for the company’s debts beyond their investment. Thus, even if a stock’s value diminishes to more than zero, shareholders aren’t on the hook for any additional losses. 

Liquidation and asset distribution 

When a company goes bankrupt, its remaining assets are first used to pay off debt. From there, creditors and bondholders are first in line to receive their owed money, and if there are any assets remaining, the shareholders could receive a portion. 

Negative shareholder equity 

It’s worth noting that while stock prices can’t go negative, a company’s shareholder equity can. Negative shareholder equity means that the company’s liabilities exceed its assets, which is a sign of financial distress. This doesn’t mean shareholders owe the company money; instead, it indicates that the company owes more than it owns. 

Example of a stock losing all its value [5] 

Enron Corporation, once a titan in the American corporate landscape, serves as a cautionary tale in the stock market world.  

Previously recognised for its ventures in energy trading, its ascent to being the seventh-largest U.S. company was meteoric. However, this success was shadowed by deceitful accounting practices, including the use of loopholes and deceptive financial reporting, which concealed massive debts and inflated profits.  

When these irregularities surfaced, the company’s stock price, once at a peak of $90 in 2000, plummeted to less than $1 by November 2001. The subsequent bankruptcy not only decimated billions in shareholder value but also led to pivotal regulatory changes like the Sarbanes-Oxley Act of 2002, emphasising the need for transparency and ethical corporate governance in the financial sector. 

The bottom-line

There are several ways to protect yourself from losing more money than your initial investment. However, it can still happen because markets are unpredictable.You can protect your investment from the impact of negative price movements by using stop loss orders and diversifying your portfolio.

It is essential to keep in mind that stock prices can fluctuate drastically and sometimes it is impossible to predict the price movement as well as the optimal time to sell or buy. However, even during the most volatile price fluctuations, stocks cannot go negative.

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Reference

  1. “Can Stock Value Be Negative? – Finance – Zacks.” 19 Feb. 2019, https://finance.zacks.com/can-stock-value-negative-9119.html. Accessed 13 May. 2022.
  2. “Top 6 Most Shocking Stock Increases and Falls – Investopedia.” https://www.investopedia.com/articles/stocks/12/most-shocking-stock-increases-falls.asp. Accessed 13 May. 2022.
  3. “Factors That Move Stock Prices Up and Down – Investopedia.” https://www.investopedia.com/articles/basics/04/100804.asp. Accessed 13 May. 2022.
  4. “Why Is Buying Stocks on Margin Considered Risky? – Investopedia.” https://www.investopedia.com/ask/answers/041315/why-purchasing-stocks-margin-considered-more-risky-traditional-investing.asp. Accessed 13 May. 2022.
  5. “What Was Enron? What Happened and Who Was Responsible – Investopedia” https://www.investopedia.com/terms/e/enron.asp Accessed 23 Aug 2023
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