Fannie Mae: 'Cheap' stocks can always get cheaper

Q: I bought Fannie Mae stock fnm for $1.25 thinking it couldn't get cheaper. Now it's trading for 60 cents. When will it come back?

A: Well, it's come back quite a bit since you wrote to me, but you're still down almost 20%.

I'm glad you asked your question. It's a reminder to many investors who may be tempted by seemingly cheap stock prices of troubled powerhouse companies.

During the bear market that began in 2007, many former megalith companies saw their share prices nosedive to pennies. A few of the massive declines included well-known companies like American International Group, Washington Mutual, Circuit City, General Motors, Freddie Mac and as you point out, Fannie Mae.

Even after these companies' stocks fell 90% or more, and the companies themselves warned the stock might be worthless, investors couldn't resist. Some gamblers figured if these nearly dead companies could manage to show a pulse, their stock prices would soar.

That could be true. But recent history has demonstrated just how risky that proposition is. Stocks like Circuit City essentially evaporated as the companies filed for bankruptcy. GM investors found themselves holding a lemon as the stock was delisted and the remnant was renamed Motors Liquidation Co. mtlqq.

Former mortgage firms Freddie Mac and Fannie Mae are a little different. Those companies were taken under conservatorship by the federal government. The new arrangement certainly provides for the survival of Freddie and Fannie. But that's little comfort for investors who have lost big on the stocks.

Fannie's 52-week high was $8.52 and its low was 30 cents.

Until the recent rally, shares of Fannie and Freddie were down 25% and 18% respectively this year. And that's while the broad Standard & Poor's 500 index was up 11%. So much for cheap stocks being a safe place to invest.

The declines of Fannie and Freddie are a reminder that investing in shares of distressed companies isn't for the faint of heart. Just because a stock appears cheap doesn't mean it can't get cheaper. And even a stock trading for less than a $1 can deliver big-time losses as it falls further.

Unless you're willing to lose it all, you're better off avoiding such stocks.

So, when will Fannie recover? I have no idea, and I suspect no one else does either. Just know that if you hold on, you're exposing yourself to big risks and can still suffer great losses. Stocks can go to zero.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns. Follow Matt on Twitter at: twitter.com/mattkrantz

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