October 2018 - Bubbles and Bottoms for Companies -

When you have stock market bubbles, you have Initial Public Offerings, or IPO`s. New companies get listed, and will often have stellar returns on their opening day. These newly listed companies don`t necessarily have to be profitable. Well, in a normally functioning stock market companies who don`t make a profit wouldn`t even consider getting listed, not in the least because it`s just very expensive to be listed and adhere to all the regulatory paperwork. But during a bubble it`s a different world, and it seems like everyone and their mother takes a shot at getting listed and receiving funding from investors who are way too risk-hungry.
What`s the percentage of companies who are not profitable when they IPO? It is close to 80%. Almost matching the levels seen during the dot-com bubble, and far surpassing the levels of 2008.

Many of these unprofitable companies, both newly listed as well as companies who`ve been around for a longer time, not only have a problem making profit, but they will also have a problem repaying their debt. Companies in the Russell 2000, an index composed of small-cap businesses, have more than 50% of their long- and short-term debt borrowed at floating interest rates. This means that with the current rise in interest rates across the board (both long- and short-term), it will become increasingly harder for companies to repay their debt, which in turn results in even higher losses and eventually bankruptcy.

“The investor of today does not profit from yesterday`s growth”
- Warren Buffett -

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