Beware The Rise Of Unprofitable Firms

Beware The Rise Of Unprofitable Firms
Stéphane Renevier, CFA

5 months ago2 mins

Sure, interest rates are higher now, but decades of mostly falling interest rates have given rise to a cluster of unprofitable publicly traded firms. This chart shows a growing band of these profit-challenged entities, especially among those with negative profits below -5% (dark blue). All told, these days, firms without profits occupy a whopping 50% of the publicly listed company landscape.

Now, they might not be the big publicly traded kahunas – collectively they hold just a 10% slice of the market’s total revenue pie and about 13% of its jobs – but their stumble could still send ripples across the economy. And with interest rates having registered their most intense surge ever and likely to remain higher for longer, those tremors could roll in sooner than you might think.

To be fair, not all of these companies are “zombie firms” – the kind that lumber along as if dragged by the lifeline of super-low financing costs. Some are just firms with a zest for aggressive (and expensive) growth. Yet, as the cost-of-funding thermometer heads north, a good chunk of these firms – zombie or not – are likely to find themselves in a tight spot, forced to slash their workforce or stare down the barrel of bankruptcy if their path to profitability is too distant.

This could have a major impact not just on sentiment, but also on the labor market: Goldman Sachs has calculated that a 50% rise in the number of firms ceasing to operate or becoming acquired (from 8% per year to 12%, an elevated but not historically unusual level) would slow down monthly job growth by 20,000 and trim 0.2 percentage points off of economic growth. A 100% rise in the number of firms ceasing to operate or becoming acquired would see the slowdown in monthly job growth double, along with the size of the haircut for economic growth.

In this environment, your best strategy may be to seek out high-quality, profitable companies – particularly those that can handle high interest rates.



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