What is a Torpedo Stock?
How Does a Torpedo Stock Work?
Torpedo stocks are named for the manner in which a ship descends, sinking into the sea following a torpedo attack on its hull. Likewise, the issuing company of a stock that has been deemed a torpedo stock has experienced a significant internal change that has damaged its ability to generate earnings. As a result, it is unable to pay out dividends. Its value subsequently continues to decline. As it bears fewer and fewer signs of recovering, investors sell, causing the value to decline further.
To illustrate, suppose company XYZ undergoes an internal change due to poor judgment on the part of its management. The change results in a sharp decline in earnings. As a result, the market value of the stock declines sharply as well. During subsequent quarters, XYZ's earnings become successively lower and more and more investors sell their XYZ shares. XYZ's stock is now a torpedo stock since its value continues to decline along with a loss of investor confidence and no signs of recovery.
Why Does a Torpedo Stock Matter?
A stock that has been classified as a torpedo stock serves as an indicator that it might be wise for investors to sell any of their outstanding shares since such stock could have serious consequences for portfolio values.