A curious thing happened to Hertz stock in the middle of the COVID-19 pandemic: retail investors couldn’t get enough of it, even after the company declared bankruptcy, major shareholders dumped their shares and the company itself warned the equity was likely worthless.
Despite all that, online discount brokerages reported a significant uptick in trading activity – particularly on the popular Robinhood trading app, where day traders and investors appeared to take a special interest in Hertz.
It was a surge boosted in large part by young retail investors with an appetite for risk and dreams of making a quick buck off Hertz Global Holdings Inc.’s volatile stock price. Some of these investors were quoted in major news outlets saying they were using government support cheques to trade online, while others shrugged off questions about risk, noting that with sports and all other forms of entertainment halted, playing the stock market would have to suffice.
While some of these investors reported big profits, the problem with this approach is that it’s speculating on price versus investing in value, without a proper understanding of the fundamentals of the company or the specifics that led to the bankruptcy filing and how its debt is structured.
It’s also a strategy that relies on the greater fool theory, or the idea that while a stock may not be worth what you’re paying for it, there’s so much excitement around it that someone will pay a higher price (a greater fool than you).
In the case of Hertz, the rental car company has common shares but it also has senior and junior debt, and that debt gets serviced first in the event of a bankruptcy. Senior debt holders are first in line to get paid in full, followed by the junior and unsecured debt, with equity holders getting the leftovers. This hierarchy means equity holders typically get wiped out when a company files for bankruptcy, and it was pretty clear that would be the case with Hertz because its unsecured, junior debt was trading at about $40 on par of $100 – suggesting even the unsecured debt wouldn’t get full repayment.
A few days after the bankruptcy filing, billionaire investor Carl Icahn sold his entire stake in Hertz for $39.9 million (even though it was reported to have been worth around $1.6 billion) and the New York Stock exchange said it was looking at delisting Hertz.
Given significant interest in the stock post-bankruptcy, Hertz made the unusual move to ask a judge to allow them to raise as much as $1 billion via new equity issuance, in order to help with restructuring efforts – a stock offering the company warned repeatedly could ultimately prove worthless. The request was initially approved by the court, but suspended when flagged for regulatory review by the U.S. Securities and Exchange Commission (SEC) – just one day after Hertz announced plans to issue up to $500 million worth of new shares.
The initial buying frenzy that drove up Hertz’s “worthless” stock was driven by retail investors, and whether these same investors jumped on the chance to buy more shares through that additional issue remained to be seen at the time of writing.
But as tempting as it might be to jump into an opportunity that seems too good to miss, investors should proceed with caution: from the dotcom bubble to bitcoin, every trendy asset seems like a great idea until the greater fool is you.