Companies That are Walking Dead

What is a “zombie company” and how to identify them?

This newsletter is summed up in this video➡️https://youtu.be/v0_cjX6-JzM

642 companies filed for bankruptcy in 2023. This is the most since 2010. These are companies that you and I could have invested when there was hope for a profitable future.

These are the latest examples of “zombie companies”. Zombies are the businesses that don’t earn enough money to fund their operations. They depend on money from lenders and shareholders to cover some of their expenses. Banks lend money in hopes that the company can become profitable and pay off the loans while investors buy equity, hoping management can build a more valuable operation. Low interest rates and Fed policies that encourage investment create an environment where it’s easier for zombies fund their failing operations.

Problem

Many investors don’t know where to begin to identify and avoid investing in these zombie companies.

Solution

By knowing where to look on the cash flow statement, an investor can quickly identify a company that is bleeding cash.

Here’s how to identify a zombie company:

Investing News is Entertainment, Not Advice

Remember, any investing news outlet is not from your financial advisor. It is intended to get views and engagement (entertain) not protect and secure your financial future (advising). This is why WeWork and Lordstown Motors were popular and constant in the news circuit at one point and now they’ve filed for bankruptcy.  Outlets like CNBC, Bloomberg, and Yahoo Finance may have credibility, but remember, their objective is entertainment.

Read the Cash Flow Statement

A potential zombie can be identified by looking at the cash flow statement. Let me show you how. ⬇️

The cash flow statement is self explanatory, it shows the inflows and outflows of cash in a business. It links the income statement to the balance sheet. This statement explains how the operations of the business impact the cash balance.

There are three sections of the cash flow statement.

1. Cash Flows from Operating Activities - If I made shoes, this would be all sales minus the cost to create the product and run the business (employees, sales, administration, cost of materials, etc.). Zombies will report negative cash flows from operations year after year.

2. Cash Flows from Investing Activities - This is the required reinvestment into the business to continue operations. Think of the equipment that a shoe company would have to maintain and replace to maintain or expand operations. Acquisitions are also included in the investing section of the cash flow statement.

3. Cash Flows from Financing Activities - This section includes all transactions regarding debt and equity/ownership in the business. When a zombie company is bleeding cash, this is the section that displays how they are funding the operation. Typically, they are steady taking out debt or selling more shares to investors willing to take the risk.

👀 The main signal of a zombie company: 
Consistent negative cash from operations with positive cash from financing.

Watch this video if you’d like a visual example of reviewing a cashflow statement ➡️https://youtu.be/v0_cjX6-JzM

A few things to keep in mind as a wise investor:

All investing assumes some level of risk.🚩

Understanding the business is the best way to reduce risk.🧠

Reading the financial statements is the best way to understand the business.📑

Stay tuned for resources on how investors should read financial statements.➕