Protect your investments from the bankruptcy wave by steering clear from these types of businesses! [Wednesday: The Independent Investor]
Miles Everson’s The Business Builder Daily speaks to the heart of what great marketers, business leaders, and other professionals need to succeed in advertising, communications, managing their investments, career strategy, and more.
A Note from Miles Everson:
Hello!
Welcome to “The Independent Investor!”
Every Wednesday, we publish articles about basic investing tips. Our goal in these articles is to help you strategically think about your financial decision-making and achieve true wealth in the long run.
Today, let’s focus on an investment insight from my friend and colleague, Professor Joel Litman.
Read on to know how you can keep your investments safe when the market’s swelling bankruptcy wave crashes.
Miles Everson
CEO, MBO Partners
Chairman of the Advisory Board, The I Institute
The Independent Investor
According to Professor Joel Litman, Chairman and CEO of Valens Research and Chief Investment Strategist of Altimetry Financial Research, now is a terrible time to be a cash-poor business… and lots of companies are finding this out the hard way.
Why?
In March 2023, in its ongoing battle against high inflation, the U.S. Federal Reserve increased rates by another quarter percent. That brought the federal-funds rate to 5%, marking its highest level since the Great Recession of 2008.
Here’s the thing: Despite the Fed’s aggressive rate hikes, inflation remained stubborn…
Photo from BOOM
First-quarter core personal consumption expenditures – the Central Bank’s preferred inflation gauge – came in at 4.9%, up from the previous quarter’s 4.4%. With such news, U.S. companies started paying back the cash they borrowed before further rate hikes.
Starting next year, these companies would need more cash to cover obligations and pay down their debts. The problem is, they might struggle to access the capital they need because refinancing will be expensive and banks are already tightening their lending standards.
[Refinancing: The replacement of an existing debt obligation with another debt obligation under a different term and interest rate.]
Today, we’ll explain why those who didn’t already figure out their financing might soon be facing issues. As an investor, it’s critical to watch out for these signs of vulnerable “zombie companies” so you can be safely out of the way when the looming wave of bankruptcies starts to crash.
[Zombie Company: A company that needs bailouts to operate, or an indebted company that is able to repay the interest on its debts but not repay the principal amount.]
Zombie Companies on Your Investment Lawn? Here’s How to Steer Clear From Them
Based on the Senior Loan Officer Opinion Survey, around 45% of banks tightened their lending standards for commercial and industrial (C&I) loans in the first quarter of 2023.
Note: Banks give out C&I loans to companies to help them invest and grow their businesses. Additionally, these loans are vital to the overall economy.
Through most of 2022, C&I loan balances grew steadily. However, in the first quarter of 2023, C&I lending began to contract and it’s reaching a critical level. The result of that?
Companies began looking for other ways to raise capital.
One way is through a fire sale. This is when companies sell their assets as fast as they can, and sometimes at steep discounts.
Some firms that have started to pursue this strategy are pharmaceutical giant Eli Lilly, paint manufacturer Sherwin-Williams, and industrial technology company Vontier.
Well, it’s true that a fire sale can help businesses pay bills for a while, although it’s a sign of desperation. Besides, not all companies can afford to sell their assets at fire-sale prices. For those that can’t, things are getting ugly.
According to data from the S&P Global Market Intelligence, U.S. corporate bankruptcy filings hit a 12-year high in the first 2 months of 2023.
From that data alone, you’ll see it’s the worst start to a year since the U.S. came out of the Great Recession. The data even topped the number of bankruptcies recorded during the COVID-19 pandemic.
It’s clear that lots of companies are struggling to survive in this era of tight credit standards. Unfortunately, some sectors are feeling the pressure more than others.
For instance: The number of bankruptcy filings for consumer discretionary companies far outpaced every other sector. In February 2023 alone, 11 companies under this sector went bankrupt.
That’s more than double the amount of bankruptcies in any other sector! Meanwhile, 3 other sectors – health care, industrials, and financials – came in second with 5 bankruptcies.
Some affected companies include pet food supplier Independent Pet Partners, home decor company NBGHome, and retailer Tuesday Morning.
What do these businesses have in common?
They failed to adapt to the changing economic landscape brought about by the pandemic. They took on debt while it was cheap, regardless of their ability to pay it back.
These “zombie companies” did it to get by in the short term. However, they never did the hard work to adjust their businesses to the ways the pandemic has permanently changed society.
For example: The “at-home revolution” meant people are never going back to the mall the way they used to. That’s because during the pandemic, many of them discovered they liked buying stuff online and having it appear on their doorsteps a few days later.
Even a behemoth like Walmart had to adjust to this new reality by making major investments in e-commerce and enhancing its ability to sell via its website.
Sadly, “zombies” like the other companies mentioned above didn’t adapt, and they’re about to pay the price.
Sure, cheap debt enabled them to delay the inevitable. They were able to keep their heads above water, thanks to the remnants of a strong business cycle. Now, the debt they took on is starting to weigh on them.
What’s worse?
If they can’t refinance, bankruptcy may be the only way out for them.
So, what’s the key takeaway from this topic?
As an investor, pay attention to those companies that have debts coming due AND don’t have enough cash to handle such debts.
Do your own research.
Companies that start divesting assets at fire-sale valuations might just be delaying what’s ahead and might not be able to refinance. That means such companies could soon be added to the list of corporate bankruptcies.
Once you see signs of these kinds of companies, steer clear from them. You wouldn’t want to see yourself stressing over such businesses when the market’s swelling bankruptcy wave crashes.
Take note of these tips to protect your investment portfolio!
Happy midweek, everyone!
(This article is from The Business Builder Daily, a newsletter by The I Institute in collaboration with MBO Partners.)
About The Dynamic Marketing Communiqué’s
“Wednesdays: The Independent Investor”
To best understand a firm, it makes sense to know its underlying earning power.
In two of the greatest books ever written on investing, the “Intelligent Investor” by Benjamin Graham and “Security Analysis” by David Dodd and Benjamin Graham (yes, Graham authored both of these books), the term “earning power” is mentioned hundreds of times.
LITERALLY.
Despite that, it’s surprising how earning power is mentioned seldomly in literature on business strategy. If the goal of a business is wealth creation, then the performance metrics must include the earning power concept.
Every Wednesday, we’ll publish investing tips and insights in accordance with the practices of some of the world’s greatest investors.
We make certain that these articles help you identify and separate the best companies from the worst, and develop your investing prowess in the long run.
Our goal?
To help you get on that path towards the greatest value creation in investing.
Hope you’ve found this week’s insights interesting and helpful.
Stay tuned for next Wednesday’s “The Independent Investor!”
Cheers,
Kyle Yu
Head of Marketing
Valens Dynamic Marketing Capabilities
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