This morning, when common stock shareholders of American Airlines (AMR $0.31) awoke and had a chance to read today’s news, they found out that the company they had invested in had declared bankruptcy overnight.  When they then immediately looked to see what their shares were worth, they found the shares to be trading at approx. 31 cents, down from yesterday’s close of $1.62/share and down from the share price at the beginning of the year of approx. $8.63/share.  This is terrible.  For any common stock investor, this is almost the worst event that you can experience!  We say that this is almost the worst that an investor can experience, because it can get worse.  The worst experience perhaps is the company declaring bankruptcy, the shares no longer trading, and the shares eventually being given a value of zero by a bankruptcy judge.

Prudent stock investors avoid such problems.  Investors who either misunderstand the markets or ignore warning signs get hurt.  This thinking applies to investors from the past in companies like Enron, today’s shareholders of American Airlines, and tomorrow’s troubled company.  There are almost always warning signs.  We would say that there are ALWAYS warning signs, but that’s probably not historically accurate.  There can be a sudden event that wipes out a company, but it is extremely rare.

Let’s focus on the kind of thinking which we use as successful stock investors to help us avoid such trouble AND help us identify warning signs –

1. First, only own stocks that you HAVE A REASON to own.  That sounds simple, but millions of people have stock portfolios littered with stocks of companies that they know nothing about or whose business fundamentals have changed so dramatically they’d be hard pressed to say why they own it.  So, look at your portfolio of stock holdings.  If you see stocks that you really don’t know anything about, take some time to find out what condition the company of each of the stocks is in and then make an informed decision as to whether to be continue holding the shares or sell them.
2. Here are some valid reasons to own a stock – * The background market (S&P 500 for example) is flat or in an uptrend, the business fundamentals of the company are sound, AND the shares are in a defined uptrend.  Very good.
   * The background market (S&P 500 for example) is flat or in an uptrend, the business fundamentals of the company are sound, the shares are in a lateral range and do not appear to be moving higher, but the company pays a good dividend.  Fine.
   * The background market (S&P 500 for example) has stabilized, the business fundamentals of the company are improving, and the share price is coming up out of the basement.  Good, better days may be on the way.
3. Own stocks when the background market (S & P 500 for example) is lateral to up-trending.  Avoid owning stocks when the background market  is in a downtrend or the investment climate is unpredictable.  Get practiced at heading to the sidelines with your cash (all of it) or purchase some form of “insurance” like puts on the S&P 500 when you see that the market is in trouble.  Why let your stock holdings go down 50% or more in value if the market is heading into a correction due to – for instance – fears of a recession coming ahead?  “Buy and Hold” investing is accurate – if it means buying and holding when the market say’s its a good idea.  Unfortunately this strategy has been twisted by the financial service industry to hoodwink 10’s of millions of Americans into leaving their money at risk to the markets so that financial firms can continue earning fees, independent of performance. Local fishermen avoid going fishing when the fish aren’t there or the weather is dangerous.  Shouldn’t you do the same with your hard earned savings?
4. If the background market is ok, but your stock investment breaks key support to the downside on volume, strongly consider selling the stock – unless you have a very good reason to own it.  In the case of American Airlines (AMR), the market was in an uptrend in January of 2011, but AMR jolted downward on January 19th.  To be fair, so did other airlines stocks in the face of the increase in trouble in the Middle East.  It was a prudent time to exit AMR, recognizing that on the same day AMR posted another quarterly loss of significance.  Combining the quarterly earnings loss, the technical price drop in the shares, and the increase in geo-political troubles, there was no reason to own the shares.  An experienced investor may not have immediately sold the shares, but put in a stop at $7.45, just below near term significant support of $7.50.  If the stock was not able to hold the $7.50 line, then it was time to sell the shares. Here’s a good article detailing what has happened to American Airlines, and gives you an idea of the condition of the company that many shareholders continued to participate in – despite the warning signs.   Article: NYTimes.

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Please remember – at the Stock Market Companion we do not and cannot give individual investment advice. According to the State of Washington RCW21.20.005 the Stock Market Companion is not a Registered Financial Advisor and we do not render any advice on the basis of the specific investment situation of a particular individual. This information is for a wide readership and is not intended for any particular individual,  and under no circumstances should our Free Report, Market Update or Watchlist be considered an investment recommendation or plan for any specific individual.  By accessing this material, you agree that the Stock Market Companion will not be held liable for any actions taken by a subscriber or other parties.  Please seek the counsel of a broker or other licensed investment professional for accurate pricing and concerning the suitability of all investments that you may be considering. Disclosure : You understand that the Stock Market Companion holds positions in the above mentioned securities.  Based on market related or personal events these positions may change without notice.