What does PG&E’s bankruptcy mean to investors?
Q: When my mother died, I inherited several hundred shares of Pacific Gas & Electric stock, which she had inherited from her father. Does PG&E’s bankruptcy mean my shares are worthless?
A: While I can’t really opine on individual investments in this column, the PG&E bankruptcy gives us a great chance to talk about corporate bankruptcy and what it means for investors. Please remember nothing in this column is meant to be personal financial or legal advice.
There are two main types of corporate bankruptcy: Chapter 7 and Chapter 11. Under Chapter 7, the company is closed and the assets are sold to satisfy the company’s creditors. Chapter 11 bankruptcy allows the company to stay in business while it works to reorganize its obligations with its creditors. PG&E declared Chapter 11 bankruptcy.
From a financial perspective, every business is comprised of assets, liabilities and equity. In PG&E’s case, these assets include things like buildings, power plants, transmission lines and trucks. Liabilities include bank loans, vendor credit and bonds sold to the public. Equity is whatever is left over after you subtract the liabilities from the assets. As a shareholder, you have an equity stake in PG&E.
When a company files for Chapter 11, a Trustee is appointed to oversee the development of a reorganization plan. The company’s creditors form a committee to make sure their interests are properly reflected in the reorganization plan. Shareholders also form a committee to negotiate on their behalf. When a plan is finally agreed to by creditors and shareholders, a federal bankruptcy court reviews the plan to make sure it is fair to all parties. Once it is confirmed by the court, the plan is implemented. If all goes well, the company will eventually emerge from bankruptcy stronger than it was at the outset of the proceedings.
When it comes to bankruptcy settlements, creditors come before shareholders. This means equity holders usually take a big hit in bankruptcy and are often wiped out. However, the PG&E bankruptcy is different from most.
At this point, we don’t know the full extent of PG&E’s liabilities. Much of the concern over their situation is based on assumptions about their possible role in California wildfires. If the judgments come in better than expected, there may be significant shareholder value left in the company. In fact, some investors are criticizing PG&E’s board for being too quick to file for bankruptcy. This may be why PG&E’s share price jumped over 16% on the day they declared bankruptcy.
In closing, I need to reiterate a couple of important investment principles highlighted by the PG&E case. First, you mentioned that your PG&E stock has been in your family for three generations. Unfortunately, this is not uncommon. But stocks make terrible family heirlooms. Companies change and their operating environments change. What may have been an excellent stock in your grandfather’s day may not be so excellent today. If you want a family heirloom, buy a nice piece of jewelry. If you are going to invest, keep your investments current. Try not to mix the two activities.
Second, keep your portfolio diversified. Diversification is how we protect ourselves from our own ignorance. You and I cannot know what is really going on inside PG&E or any other company unless we are well-placed inside the company. We also have a difficult time knowing what the future will bring. We can shield ourselves from these unknowns by making sure our exposure to any single stock is never more than 4 percent of our portfolio. Possible exceptions to this rule can be made for those who receive large restricted stock grants.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.