The Problem with Peak Prices and Record Low Yields:
- In Seth Klarman’s “A Margin of Safety” he discussed the 1980s junk bond mania before it imploded
- Back then many bonds were issued by companies that could not afford to pay the interest expense
- That meant bond owners “claimed to have earned interest income in excess of profits earned by the underlying business”1
Klarman asserted this was “financial alchemy” and we are inclined to agree. The chart below shows that despite record low interest rates, the market cap of firms that cannot afford to pay their interest expenses has never been higher
Approaching 600 names we used some simple criteria to create a narrower list of firms. The below companies suffer not just from an inability to pay their bond-holders out of income but also:
- The firm cannot pay their interest expenses now and also could not pay them prior to Covid-19
- Traded at over 10x price to sales – historically a high-hazard valuation metric we briefed in The Rise of the Reckless
- We excluded bio-tech
- We only included firms over $1bn in market cap
Please be on the look-out for our upcoming take-aways from our much cherished copy of A Margin of Safety Risk Averse Value Investing Strategies for the Thoughtful Investor by Seth A. Klarman. While certainly out of style, we are deeply grateful for Mr. Klarman’s teachings about the importance of avoiding investing fads and capital preservation.
- Margin of Safety Risk-Averse Value Investing Strategies for the Thoughtful Investor, Seth A. Klarman, p. 60
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