Waking the Zombies!

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Dear Fellow Expat:

Some people ask why the aliens haven't made contact yet.

It could be that we're too busy as a species being distracted by pop stars dating NFL players... Or that we spend all of our time restlessly worried about politics.

It's possible they got here and turned around after watching a Presidential debate.

If there is an intelligent life out there, I'm sure they understand modern finance better than us. They probably look at our stock market... and wonder why we continue to throw good money at bad companies.

How do we constantly allow our money to chase an entire class of fantastically absurd public stocks with no business existing? Let's discuss.

Today, I quickly screened stocks on GuruFocus with three simple factors.

I'm looking for companies that shouldn't have much shelf-life in the future.

  • First, I removed all drug manufacturing, biotech, financial, and real estate firms. I included stocks in every other sector that were traded on exchanges.
  • Second, we screened for unprofitable companies... That's easy because their Price-to-earnings (PE ratio) will run at a loss.
  • Third, we added companies with a price-to-sales ratio of over 10. Remember... these companies would need to pay ten or more years of revenue (not profits - every dollar coming in the door) to justify their valuations. This valuation is mathematically insane to anyone who lived through the Dot Com bubble.

That left me with a list of 107 companies.

Many software, cybersecurity, and hardware companies are priced for extreme growth within these categories. But for every one of these companies that does grow into its valuation, we can anticipate that two or three won't make it.

There are dozens of other companies that leave me scratching my head...

How are they not still tiny investments backed by niche venture capital investors?

Why do big ETFs run by BlackRock so widely hold them? Why are retail investors investing in unprofitable, niche stocks poised to go to zero eventually?

The answer... starts with the Fed... and then results from bad incentives.

I'm not saying these companies are founded on bad ideas.

But many of them are not ready for prime time.

They result from rushed IPOs and reverse mergers that pulled Venture Capital forward and dumped shares on retail investors who didn't understand the risk or the fundamentals behind them.

They result from low interest rates, cheap money, eager Wall Street banks looking to squeeze money out of retail investors, and ETF managers who don't care about performance (just expense ratios and short-lending fees).

Consider the following public companies trading on U.S. exchanges...

First, ask... would you actually invest in these companies?

Then feel free to ask... why this is a public company?

  • AquaBounty Technologies (AQB): This company makes genetically modified salmon. Not even a great fiction writer could come up with this aquaculture company. It's been around since the early 1990s and is incredibly unprofitable. Are you shocked to read that? The F score is 3 (not good), the Z score is negative (even worse), and gross margins are NEGATIVE 538%. Shares are off 99% since it went public. Why it's public shouldn't surprise you in the Zero Interest Rate Policy (ZIRP) era.
  • Sky Harbour Group (SKYH): A self-described "emerging growth company" that owns private airport hangers for the wealthy. It's basically a Yacht Club but for the air. You can put on aviators and an ascot and tell everyone that you're "taking to the skies" today while you watch the stock decline by 50% since going public in 2020. If you thought WeWork was a lousy idea... take a look at Sky Harbour Group. The long-term debt-to-equity ratio is... 10.3x.
  • Virgin Galactic (SPCE): Richard Branson is a genius. He found a way to bring a space exploration company that wasn't ready for the primetime public and made a ton of money without continuing the venture capital route. They'll be bankrupt soon enough. This is one of the worst balance sheets of any public company. But... at least it's trading at book value (finally) at just $1.44.
  • Sack Parente Golf (SPGC): This company is a "technology-forward golf company" that makes "putters that defy convention." Sure... shares are off 65% since going public in August and have negative book value. Why is this a thing?

The list doesn't stop there. There are energy drinks, language software, and many alternative energy companies that wouldn't survive without government subsidies.

They are all priced for extreme growth... and carry extreme debt.

All in a higher interest rate environment.

Their time is coming to a close.

As interest rates remain elevated and the Fed doesn't move to accommodate the markets like it has over the last decade, perhaps we'll see a cleansing. We can stop operating in a market where bad incentives create massive misallocations of capital.

I'll wager that roughly 80% of those 107 companies won't exist in the next few years or will be taken private with bids under their current share prices.

As refinancing challenges heat up, look for these Zombies to stay in the ground.

I hope that investors will wake up.

They'll turn to the energy sector, which is still severely undervalued. They'll look to great companies with actual earnings and customers unrelated to the Federal government. They'll buy self-sustaining businesses with long-term viability.

We'll talk more about names like John Deere (JD), my favorite AI company for the next decade in an industry that matters...

Stay positive,

Garrett Baldwin

Secretary of Defense