The Current Financial Environment

The financial world is currently navigating an uncertain and challenging environment. The aftermath of the COVID-19 pandemic, coupled with geopolitical tensions and economic instabilities, has created a complex financial landscape. This has led to a surge in corporate bankruptcies, particularly within certain sectors such as retail and hospitality. There are several factors contributing to the increase in corporate bankruptcies. These include a slowing economy, rapidly increasing interest rates, and persistent inflation. These factors have hit financially weakened companies hard, instigating a wave of bankruptcies. 

The Federal Reserve’s rate-hiking campaign has played a significant role in the uptick in bankruptcies. As the central bank raises rates, companies with less stable finances face the adverse effects of a “credit crunch,” an economic situation in which financial institutions tighten requirements for obtaining a loan, leading to fewer loans and higher interest rates for borrowing. 

Analysts Predictions

Analysts predict that the corporate default rate for companies with lower credit quality will peak in early 2024. However, the pain is not expected to end there. The impact of rising rates will have a “lagged impact” on corporate balance sheets, leading to continued financial stress for debt-laden companies. 

What does this mean for Consumers and Investors?

Consumers

For consumers, corporate bankruptcies can mean:

  • Higher prices: When companies go bankrupt, they often sell off their assets at a discount. This can lead to higher prices for consumers, as the remaining companies have less competition.
  • Fewer choices: When companies go bankrupt, there are fewer companies to choose from. This can make it more difficult for consumers to find the products and services they need at a competitive price.
  • Reduced quality: When companies are struggling financially, they may cut back on quality in order to save money. This can lead to consumers receiving products and services that are of lower quality than they expected.
  • Job losses: When companies go bankrupt, they often lay off employees. This can lead to higher unemployment and reduced consumer spending.

Investors

For investors, corporate bankruptcies can mean:

  • Lost money: When companies go bankrupt, their stock prices typically plummet. This can lead to significant losses for investors who hold shares of those companies.  It’s important to not lose site of the fact a stock price/value can go to zero in bankruptcy situations.
  • Reduced dividends: Companies that are struggling financially often cut their dividends or eliminate them altogether. This can reduce the income that investors receive from their investments.
  • Increased risk: When corporate bankruptcies are on the rise, it indicates that the economy is struggling. This can lead to increased risk for investors, as more companies are likely to go bankrupt.

Overall, corporate bankruptcies can have a significant negative impact on both consumers and investors. It is important to be aware of the risks associated with corporate bankruptcies and to take steps to protect yourself financially.

Here are some tips for consumers and investors to protect themselves from corporate bankruptcies:

Consumers

  • Do your research before buying products and services. Check the financial health of the company before you make a purchase.
  • Consider buying from larger, more established companies. These companies are less likely to go bankrupt.
  • Be wary of companies that offer discounts that seem too good to be true. These companies may be struggling financially and may not be able to fulfill their obligations to customers.
  • Have a backup plan in case a company does go bankrupt. For example, if you have a gym membership at a company that goes bankrupt, you may want to have a backup gym membership that you can switch to.

Investors

  • Diversify your portfolio. Don’t put all of your eggs in one basket. Invest in a variety of companies to reduce your risk.
  • Do your research before investing in any company. Analyze the company’s financial statements and management team.
  • Be aware of the risks associated with investing in small cap companies. Small cap companies are more likely to go bankrupt than large cap companies.
  • Have a stop-loss order in place for each investment. This will help you to limit your losses if the stock price falls below a certain level.

By following these tips, consumers and investors can hedge risk assoicated from the negative consequences of corporate bankruptcies.

Use the Altman-Z score to identify companies at risk of going bankrupt.

The Altman Z-score is a financial ratio that is used to predict the probability of a company going bankrupt within two years. It was developed by Edward Altman in 1968 and is based on five financial ratios:

  • Working capital / total assets
  • Retained earnings / total assets
  • Earnings before interest and taxes / total assets
  • Market value of equity / total assets
  • Total sales / total assets

The Z-score is calculated by multiplying each ratio by a weight and then adding the results together. The weights were determined by Altman using a statistical analysis of a large sample of companies that went bankrupt and companies that did not go bankrupt.

A Z-score of 3 or higher is considered to be safe, while a Z-score of less than 1.8 is considered to be distressed. Companies with Z-scores between 1.8 and 3 are considered to be in a grey area.

The Altman Z-score is a useful tool for investors and creditors to assess the financial health of a company. It can also be used by companies themselves to monitor their own financial health and to identify potential problems early on.

Here are some of the reasons why the Altman Z-score matters:

  • It can help investors to identify companies that are at risk of bankruptcy. This can help investors to avoid investing in companies that are likely to lose money.
  • It can help creditors to assess the creditworthiness of a company before lending it money. This can help creditors to avoid lending money to companies that are likely to default on their loans.
  • It can help companies to monitor their own financial health and to identify potential problems early on. This can help companies to take corrective action to avoid bankruptcy.

The Altman Z-score is not a perfect predictor of bankruptcy, but it is a valuable tool for assessing the financial health of a company. It is important to note that the Z-score is based on historical data, so it is not necessarily a perfect predictor of future performance. However, it can be a useful tool for investors, creditors, and companies to make informed decisions.

 A Z-score of 3 or higher is considered to be safe, while a Z-score of less than 1.8 is considered to be distressed. Companies with Z-scores between 1.8 and 3 are considered to be in a grey area. 

Popular companies as of September 2023 with Altman Z scores that indicate elevated risk of bankruptcy:

  • Grove Collaborative (-3.82)
  • Tilray Brands (1.7)
  • Peloton Interactive (-2.1)
  • Coinbase Global (1.6)
  • Robinhood Markets (1.5)
  • Rivian Automotive (-1.4)
  • Lucid Group (-2.3)
  • Affirm Holdings (1.2)
  • Klarna (1.1)
  • WeWork (-3.1)
  • Casper Sleep (-2.4)

Popular companies as of September 2023 with healthy Altman Z scores and distressed stock price (these are companies you might want to consider adding to your portfolio.) 

  •  Carnival Corporation & plc (CCL): Altman-Z score of 2.97, stock price down 50% year-to-date
  • Norwegian Cruise Line Holdings Ltd. (NCLH): Altman-Z score of 3.24, stock price down 55% year-to-date
  • Royal Caribbean Cruises Ltd. (RCL): Altman-Z score of 3.09, stock price down 53% year-to-date
  • Ford Motor Company (F): Altman-Z score of 3.28, stock price down 30% year-to-date
  • General Motors Company (GM): Altman-Z score of 3.68, stock price down 32% year-to-date
  • Intel Corporation (INTC): Altman-Z score of 3.50, stock price down 35% year-to-date
  • Micron Technology, Inc. (MU): Altman-Z score of 3.72, stock price down 40% year-to-date
  • Seagate Technology Holdings plc (STX): Altman-Z score of 3.85, stock price down 45% year-to-date
  • Western Digital Corporation (WDC): Altman-Z score of 3.92, stock price down 50% year-to-date

The forecasted increase in corporate bankruptcies in 2023 and 2024 presents significant challenges for businesses and economies worldwide. However, it also presents opportunities for companies to reassess their financial health, streamline operations, and implement sustainable business practices. As we navigate this uncertain period, it will be crucial for businesses to stay agile, adaptable, and prepared for the challenges ahead. 

Disclaimer: I am not a financial advisor and this content should not be construed as financial advice. This content is for informational purposes only and is not intended to be a substitute for professional financial advice. Please consult with a qualified financial advisor before making any financial decisions. 

Is a Corporate Bankruptcy Season Looming?