Last fall a client called and wanted our opinion on buying GM stock. He said the price was so low and it had to be a great buy... and surely the government wouldn’t let GM declare bankruptcy?

We told him at the time that we wouldn’t invest in any automotive related company, that the risk was too great. We said that unfortunately, bankruptcy was probably the only way GM would survive long term. The client didn’t want to hear what we had to say. He brought up the fact that the government saved Chrysler from bankruptcy years ago and surely they would do the same for GM.

We told him that there were many other ways to invest his money in good companies that weren’t in financial trouble, companies that were in industries that were less volatile. Why pick a company with all the problems GM has?

The Wednesday before GM declared bankruptcy, a client was referred to us by a local attorney. The client, a widow, still held GM stock and her son-in-law (who supposedly was managing her portfolio) called her to tell her to sell the stock. Why did he wait so long? Did the son-in-law think she could do better holding on to GM stock than taking the loss and reinvesting in something with a positive outlook? We helped her sell her stock on the Thursday before GM declared bankruptcy. She received approximately $ 1.29 per share. Days later it would have been virtually worthless. We wonder who bought it from her. It was probably someone who said: “surely the government won’t let GM declare bankruptcy”.

Another client who noted that Ford had so far avoided bankruptcy asked my opinion about buying Ford. Surely it must be a good buy at such a low price? A couple of years ago, before Ford’s stock price took its plunge, we had convinced her to sell her Ford stock. She had been reluctant to do so because the stock had been in her family for many years and she was emotionally tied to it. Ultimately, she was very happy she sold when she did. “But isn’t it a great buy at its current low price”, she said? While it might well be a great buy, we pointed out to her that Ford has something like $30 billion in debt, currently. If the recession lasts for an extended time, Ford might yet have more serious problems. We told her we felt the risk was too high.

The bottom line is that just because a stock has a very low price doesn’t mean it’s a good buy. Sure, sometimes companies rally back and see their share price substantially increase. But all too often, a company’s stock price is low because the company has some serious problems. Betting on one company’s severely depressed stock with the hope of a miraculous recovery is akin to gambling. There is no silver bullet in investing.