The March of the Zombies

Investors who view continuing low interest rates as an all-clear sign for heavily leveraged companies may want to look at the chart below before breaking out the champagne. It shows that at the beginning of the year, the percentage of money-losing companies that make up in the Russell 2000® Growth Index was approaching levels not seen since the dotcom bubble. Thanks to a slowing economy and the efforts of the Federal Reserve to pump money into an economy rocked by COVID-19, the situation has become even more dire.

Money-losing companies in the Russell 2000® Growth

Money-losing companies in the Russell 2000® GrowthSource: Jefferies, FactSet Research Systems Inc., and FTSE Russell, 12/31/1984 to 12/31/2019
This chart shows the total number of companies in the Russell 2000® Growth Index that did not earn money as a percentage. Weight is calculated taking these stocks
and summing their weight in the index. All indices are unmanaged. It is not possible to invest directly in an index.
Past performance does not guarantee future results.

So why does this matter? More debt may result in higher debt-servicing costs which can translate to pressure on profit margins as businesses tend to siphon from top line revenue to satisfy creditors. 
 
Margin compression is a concern for investors against any economic backdrop much less one where corporations are struggling to survive in a global pandemic. If the economic recovery fails to keep pace and consumers and corporations further reign in spending, the negative effects of interest costs will likely be amplified as fixed debt payments will eat into ever-smaller revenue streams.  
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Author

Will Nasgovitz

Nasgovitz is CEO and Portfolio Manager of the Opportunistic Value Equity Strategy, as well as the Mid Cap Value Fund, the Value Fund, and their corresponding Mid Cap Value and Small Cap Value Strategies. He also is President and Director of Heartland Funds. He has 20 years of industry experience, 16 at Heartland.

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