Investor Fears of 'Zombies' Create Bubble in Companies With High Cash Flow

Companies with healthy balance sheets are some of the best performing stocks this year, and their shares could keep rising, according to Piper Sandler & Co. strategists led by Michael Kantrowitz.

Investors are shunning zombie companies that survived for years because of low-interest rates. Macroeconomic uncertainty has instead driven US equity investors toward the firms readily able to pay their interest expenses with earnings, known as having high interest-coverage ratios.

These are the best performing stocks in the Russell 3000 this year, a broad market index, according to Piper Sandler’s analysis of 118 different factors. They found that for interest coverage, the top performing 20% of stocks did the best relative to the bottom 20%.

The Federal Reserve held interest rates at a 22-year high for a second straight meeting on Wednesday, and Chair Jerome Powell reiterated that there’s a long way to go before inflation gets back to target levels, suggesting borrowing costs are likely to stay high for some time. Investors are gravitating toward companies that can bear this expense. The outperformance of companies with high interest coverage ratios is so dramatic it could be viewed as a bubble, but it probably won’t deflate soon, Kantrowitz said.

“We believe this bubble has room to run, and is unlikely to pop until either zombies go bankrupt, or interest rates collapse to much lower levels to keep them alive,” the strategists wrote. “If we’re in an extended period of higher rates for years, this could be the factor of the decade.”

Relative Performance Interest Coverage Factor