As a wise man once said: “The bold print giveth, but the fine print taketh away.”

Some investors may well be enticed by the common stocks of post-reorganization companies. Here’s why:

In a typical Chapter 11 Bankruptcy proceeding, most creditors are not made whole in cash. So instead of liquidating and giving creditors whatever proceeds are available from the sale of assets, companies offer equity stakes in the newly reorganized company. This both keeps the company alive and provides a better deal for creditors since they extract more on the dollar by owning stock rather than getting a smaller value of cash in liquidation.

But because many creditors either a) prefer to just have the cash (at least after the new equity starts trading) or b) cannot own the equity (due to regulatory issues, the creditors’ covenants to their own constituency, etc.), the stock of the reorganized company suffers a sell-off unrelated to the nature of its business.

Because the companies (usually) come out with a lightened debt load and can be okay businesses post-Chapter 11, this selloff can lead to bargains for investors willing to purchase what everyone else is dumping. That’s all well and good.

But obviously these “special situations” are not universally good investments simply by virtue of being post-reorganization stocks (after all, they WERE struggling businesses, otherwise they would not have needed to file Chapter 11 in the first place). Luckily, the reorganization plan and disclosure statements filed with the SEC often contain quite thorough and useful information on the company post-Chapter 11, often including projections for earnings many years out.

Which brings me to an example from very recent history (i.e. about 2 months ago). Winn-Dixie Stores (WINN) emerged from bankruptcy in November, and the stock rose sharply before — you guessed it — the selloff. Looking at the situation superficially, WINN appears to trade for just 11-12 times earnings and has little debt. This may jump out to some as a bargain.

But even ignoring the lengthy minutiae of the disclosure statement (which you can find here) and just skipping down to the juicy part at the bottom of the document entitled “Projected Statement of Operations” (go ahead and do it. I’ll wait…) reveals that management expects net income of $137 million by year 2011. Given Winn-Dixie’s market cap of $1.9 Billion right now, I ask you the following [Editor’s Note: At the time of writing, Winn-Dixie’s market cap was actually closer to $760MM. Joe made a big blunder here, and the example, not necessarily the point, is not a great one]:

Would you really want to own a run-of-the-mill grocery operation trading for 14 times earnings more than four years away? [Another Editor’s Note: No, you wouldn’t. However, since Joe botched this one and needs to take his own advice to read the small print, the actual price to earnings four years out is more like 5.5. Big difference]

I know I don’t. Even assuming that management’s projections are right (they usually never are, and often err on the generous side), and further assuming that this mediocre company will trade at 20 times earnings in four years from now, investors stand to make just about 9% on an investment. That’s not spectacular, and becomes even less enticing considering the inherent risks of the situation, including a Chapter 22 filing (Ch. 11 times 2), widely erroneous projections, and many others. [Yet Another Editor’s Note: Just to rub it in and show how wrong Joe was, this scenario would actually lead to around a 40% annualized result. Obviously, it’s still unlikely that the projections are accurate and that a grocer would trade at 20 times earnings, but you get the point].

Bottom line? Investors just have to read the fine print. Avoid falling prey to the value trap. Just because companies sell off a bit or seem to be bargains superficially does not make them wise investments. [A Final Editor’s Note: Bottom line? Joe needs to take his own advice )