07 May ASX zombies make a strong case for investment diversification
Here’s what a zombie company is and why they can be a detractor to your returns
Australian Securities Exchange (ASX) data shows more than three dozen companies have been delisted from the Australian share market so far this year.
The majority of those delistings have been voluntary, at a company’s request. But the remainder have been delisted by the ASX due to listing rule breaches including their non-lodgement of documents and failure to pay their annual listing fees.
It’s highly likely many of the latter companies were ASX zombies in disguise.
What are zombie companies?
In simple terms, zombie companies could be classified as the living dead.
They generally exhibit signs of being under financial distress for an extended period, but they are not yet insolvent or unable to trade.
Investors should avoid them, but zombie companies can be really hard to spot.
However, there are often a number of tell-tale signs that can be found by looking in their financial accounts.
For example, their market value is more than likely to be below the value of their net tangible assets. In addition, their cash flow is likely to be either negative or only just servicing their debt repayments.
Beyond their balance sheets, another tell-tale sign is their share price. Zombie companies typically experience a high degree of share price volatility, with their market value likely to have fallen sharply over time.
Are there many zombies on the ASX? Research released recently by financial services firm KPMG found that the number of zombie companies it had identified on the ASX had risen by 30% between March and the end of October last year.
This took the combined market value of those identified zombie companies on the ASX to over $3 billion.
KPMG found that mining companies (59) made up almost half of all the zombies on the ASX, largely driven by the sharp falls in nickel and lithium prices.
Technology and telco companies had the second-largest number of zombies (16), making up 13% of the ASX’s zombies, while the consumer and retail sector was third, with seven zombies making up 6%.
The importance of diversification
Diversification – spreading investments across different asset classes and regions – is one of Vanguard’s fundamental principles for investing success.
The increase in zombie companies on the ASX highlights the benefits of having good investment diversification, especially when it comes to owning shares.
One of the simplest ways to achieve that is through the use of broad market index funds, such as exchange traded funds (ETFs), which typically have shareholdings in hundreds and sometimes thousands of listed companies.
There are multiple benefits in using index funds, but most notably it’s for their diversification, because they invest in all or a representative basket of the securities that are included in an index.
Having exposure to many different companies helps to reduce share market risk because portfolios are less exposed to the ups and downs of a smaller number of individual companies, some of which may experience financial difficulties at some point in time.
With a broad range of assets in a portfolio, returns from better performing assets can help compensate for those not performing well.
Our investment team is ready to help you accomplish your financial goals and needs. Feel free to send us an email at info@centrawealth.com.au or give us a call at 08 82314709.
Article courtesy of Vanguard.
