What are 'Zombies'

Zombies are companies that earn just enough money to continue operating and service debt, but are unable to pay off their debt. Such companies, given that they just scrape by meeting overhead (wages, rent, interest payments on debt, for example), tend to be unable to invest to spur growth, are generally subject higher borrowing costs, and may be one event, market disruption or poor quarter away from insolvency or a bailout. As such, zombies are especially dependent on banks for financing, which may be viewed as a kind life support. Zombie companies are also known as the "living dead" or "zombie stocks."

Breaking Down 'Zombies'

Zombies often fail, falling victim to the high costs associated with debt or certain operations, such as research and development. They may lack the resources for capital investment, which would create growth. If a zombie company employed so many people that its failure would become a political issue, it may be deemed "too big to fail." Given that many analysts expect that zombies will eventually be unable to meet their financial obligations, such companies are considered riskier investments and will therefore see their share prices suppressed.

Zombies were first spoken of in reference to companies in Japan during the country's "Lost Decade" of the 1990s, following the bursting of its asset price bubble. During this perio companies were dependent on bank backing to remain in operation even though they were bloated, inefficient or failing. Economists argue that the economy would have been better served by allowing such poorly performing companies to fail. The term "zombies" was picked up again in 2008 in response to U.S. government bailouts that were part of the Troubled Asset Relief Program (TARP).

Zombies: What Creates Them?

While the ranks of zombie companies are small, years of loose monetary policy highlighted by quantitative easing, high leverage and historically low interest rates have contributed to their growth. Economists argue that such policies preserve inefficiencies while stifling productivity, growth and innovation. When the market shifts, zombies will be the first to fall victim, unable to meet their basic obligations as rising interest rates make their debt more expensive to service. Meanwhile, successful companies, which were less able to build on their success because of tight credit, may feel any downturn more than they should.

While keeping zombies on life support may preserve jobs, economists note that using such resources is misguided because it impedes growth at successful firms and therefore inhibits job creation.

Zombies and Investing

Because a zombie's life expectancy tends to be highly unpredictable, zombie stocks are extremely risky and are not suitable for all investors. For example, a small biotech firm may stretch its funds extremely thin by concentrating its efforts in research and development in the hope of creating a blockbuster drug. If the drug fails, the company can go bankrupt within days of the announcement. On the other hand, if the drug is successful, the company could profit and reduce its liabilities. In most cases, however, zombie stocks are unable to overcome the financial burdens of their high burn rates and most eventually go bankrupt.

Given the lack of attention paid to this group, there can often be interesting opportunities for investors who have a high risk tolerance and are seeking speculative opportunities.

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