(FORTUNE Magazine) – To hear Martin Whitman tell it, some of the safest and highest-yielding securities around are those of companies in deep trouble or even the bankruptcy courts. Whitman heads the New York investment advisory firm of M.J. Whitman & Co., one of a handful of outfits that specializes in the securities of financially shaky companies. These securities can be risky, he concedes, but they can also be highly profitable. The total annual return regularly beats the average 25% that Whitman has racked up for his clients in recent years. Investing in bankruptcies is not a step to be taken lightly. ''A lot more companies file under Chapter 11 than you would ever want to go near,'' warns one expert. Amateurs should seek the advice of a broker specializing in such securities. A good rule is to suppress the urge to buy a troubled company's common stock. ''Before a company has emerged from bankruptcy, it is better to be a creditor than an owner,'' says Whitman. The reason is that the creditors, who hold the company's loans and bonds, are in line to be paid first. Shareholders get whatever is left, which is often nothing. Experts also tend to favor the senior debt of a company, which may or may not be secured by collateral, over subordinated debt. The main lure of securities in troubled companies is not interest income, even though it is potentially lush. The 12% subordinated debentures of Damson Oil Corp. due in 2003 (see table) are selling way below face value, suggesting a yield exceeding 18%. But some troubled companies halt interest payments. Investors' real hope is for a capital gain when the company emerges from its difficulties. Some securities have quickly doubled in value. Randall Smith of New York's R.D. Smith & Co., a brokerage firm specializing in securities of troubled companies, recommends the subordinated bonds of both Petro-Lewis Corp. and Damson Oil. Though neither company is in Chapter 11, both got into trouble with oil and gas income funds, which use investors' money to buy and develop oil-producing properties. Petro-Lewis also borrowed heavily from banks both to buy properties and to pay quarterly distributions to its 180,000 investors. When oil prices began falling, investors lost millions and sued Petro-Lewis in 1984 for misrepresenting its financial position. Petro-Lewis has since settled the lawsuit and has stopped selling oil and gas income funds, as has Damson. Smith thinks both companies have promising futures as oil and gas producers. ''Because of falling oil prices, investors don't like these securities,'' he says. ''The perceived risk on their debt securities substantially exceeds the actual risk.'' A favorite security of Talton Embry, bankruptcy specialist at Magten Asset Management Corp. in New York, sells at a bigger discount. Embry has been buying Storage Technology's 11.625% senior notes due May 1, 1993, which recently fetched $505, or half face value. Once the nation's tenth-largest computer equipment manufacturer, Storage Technology went into Chapter 11 proceedings in 1984 after losing large chunks of its computer disk drive market to IBM. Embry is confident that the Colorado-based company will emerge from bankruptcy. Another security Embry likes is Beker Industries' 15.875% subordinated mortgage notes due July 1, 2003, which recently traded at $662. One of the largest U.S. fertilizer producers, Beker has been battered by the downturn in the farm economy. The company, based in Greenwich, Connecticut, filed for bankruptcy in October after defaulting on some of its debt. Embry thinks Beker will get over its troubles. One of Smith's favorite securities is not a bond at all. Warrants issued by Public Service Co. of New Hampshire, which recently sold for $4.75, entitle the owner to buy common stock at $5 a share through October 1991. Investors have avoided the stock, which sells at about $8, because the company has $1.7 billion tied up in the unfinished Seabrook nuclear power plant. Many observers fear that Public Service, which eliminated its dividend two years ago, could be forced into bankruptcy. Smith scoffs at those fears. Seabrook is 94% complete, he notes, adding that Public Service's stock will zoom to $35 a share once the reactor is started up.

CHART: COMPANY REVENUES NET SECURITY RECENT latest four INCOME PRICE 1 quarters in millions in millions Storage $656.7 ($478.9) 11.625% senior notes $505 Technology due 1993 Public Service of $516.0 $155.7 Warrants, expiring $4.75 New Hampshire 1991, to buy common stock at $5 per share Beker $234.9 ($57.4) 15.875% subordinated $662 Industries mortgage notes due 2003 Petro-Lewis $231.4 ($26.8) 13.75% subordinated $632 notes due 1993 Damson Oil $89.0 ($1.3) 12% subordinated $610 debentures due 2003 1Prices of all but warrants compare with face value of $1,000.