The Rise of Zombie Stocks
The Dead versus the Living
November 2018. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- Zombie firms, where interest payments exceed operating profits, are on the rise
- Zombie stocks perform surprisingly well
- They are expensive, volatile stocks from diverse sectors
INTRODUCTION
The Bank for International Settlements (BIS) recently published research on the rise of zombie companies, which are firms where operating profits are below interest rate payments. The research highlights that the number of these companies is proportionally increasing and that these are less productive than other firms. They also crowd out investment in and reduce employment at healthier companies. Like zombies in literature and the movies, these firms seem to have a negative impact on society. In this short research, we will analyze the performance and characteristics of zombie companies in the US stock market (try Finominal’s Alpha Analyzer for a factor exposure analysis).
METHODOLOGY
We define zombie companies by having EBITDA-to-interest ratios below one measured over a three-year period. All stocks in the US with a market capitalization above $500 million are considered. The performance of the zombie stock index is calculated via equal-weight allocations to all zombie stocks with monthly rebalancing and 10 basis points of transaction costs.
THE RISE OF THE ZOMBIE STOCKS
The number of zombie companies in the US stock market has been proportionally increasing since 1990. The current level of 8% was previously only reached in 2004. The rise and fall of zombie companies can perhaps be explained by the interest rate cycle. When interest rates are decreasing, then highly levered companies have more room to survive and are increasing in numbers, which we observe between 2000 and 2005. When the US Fed started raising interest rates thereafter, financial conditions tightened and companies were forced to restructure or declare bankruptcy, therefore decreasing the number of zombie firms.
