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Nearly Half of Small Companies Are in the Red

Nearly Half of Small Companies Are in the Red

May 24, 2024

Nearly Half of Small Companies Are in the Red

The economic outlook for America's small public companies appears increasingly dire. A staggering 42% of these businesses are currently operating at a loss, faced with a colossal $600 billion debt that must be addressed within the coming five years. This alarming figure represents three-quarters of the $832 billion total debt shouldered by the firms indexed in the Russell small cap.


The Federal Reserve's ongoing battle with inflation has resulted in persistently high interest rates, exacerbating the financial strain on these companies. In contrast to their larger counterparts, which have only half of their debt maturing in the same timeframe, small companies often lack the leverage to negotiate favorable loan terms. Bank of America's sobering projection indicates that, even if interest rates were to remain static, small cap earnings could plummet by a third, as existing debts are refinanced at higher rates, potentially pushing many firms to the brink of collapse.

The economic environment described as 'bidenomics' has not been kind to these small caps; their sales growth is virtually nonexistent. In the first quarter of 2024, revenues among these 2000 entities rose a meager 0.3%—a figure dwarfed by the inflation rate of 1.1% for the same period, effectively indicating a contraction in sales when adjusted for inflation.

As the market braces for an economic downturn, the debate centers on whether the landing will be soft or hard. The uncertainty has already taken a toll on small cap valuations, which have plummeted to levels not seen since the end of 2021, marking nearly three years of decline. In sharp contrast, the S&P 500 has seen a 14% gain, largely driven by a handful of major tech companies.

The market bifurcation is evident, with a concentration of wealth at the apex of the market, leaving a vast disparity as one moves down the capitalization spectrum. Small caps are now valued at barely half of their worth a decade ago, according to price to sales ratios, reflecting a dramatic depreciation of company values.

This financial distress is partly attributed to a Fed-driven economic model which favors large corporations with accessible financing, thereby creating a competitive disadvantage for smaller entities. Moreover, the legacy of the Fed's low-interest policies led to a misallocation of capital, funding ventures that were ill-fated from the start and choking off resources for more deserving businesses.

An increasing number of companies have been able to go public without a sustainable profit model, leading to a potential shift towards a 'zombie' economy—echoing Japan's plight—where firms subsist on a cycle of debt without real growth or profitability. This has left millions of American workers, largely indifferent to the macroeconomic forces at play, to navigate the repercussions of these financial imbalances.


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