Mixture of an outdated economic model, excessive indebtedness and rising interest rates | by Dave Coker | June 2022


OWhat effect does an outdated business model, excessive debt and rising interest rates have on a zombie society? One word: bankruptcy.

Yesterday, 90-year-old cosmetics giant Revlon filed for Chapter 11 bankruptcy. Over the past five years, we had seen the stock fall from $28.61 in November 2018 to $1.95 on June 16, when Revlon filed for bankruptcy. The graph below shows Revlon’s performance, relative to the S&P 500 as well as the Dow Jones Consumer Products Index (a grouping of its peers)

Revlon, S&P 500, Dow Jones Consumer Products Index, 2017 to 2022, source Stockcharts.com, author

While the S&P 500 and the Dow Jones Consumer Commodity Index made gains, Revlon shares lost around 91%, which is not a good investment.

But what happened? How could we have determined that Revlon was a bad investment, let alone a zombie?

The first clue would have been Revlon’s business model. Once upon a time, inspired by television commercials, women flocked to department stores to first try on, then buy makeup. Revlon kept the same business model for decades, with few changes, even as department stores closed while society embraced online shopping.

As social media exploded, we saw the emergence of new brands, led not by a rotating cast of Revlon Covergirls who sold various products such as eye shadow to perfume, but by celebrities. Celebrities who have sold the entire product line themselves. Celebrities who made their products not a simple transaction, but a whole way of life.

For example, Kylie Jenner launched a cosmetics line in 2015. Driven by an effective strategy combination of social media, reality TV and a dedicated app, in May 2020, Kylie sold her cosmetics business to Koty for $590 million. Meanwhile, Revlon has remained true to its department store-based business model, mainly rely on face-to-face saleswith little social media presence or celebrity endorsement.

Clearly, then, the business model was flawed in the age of social media, but were there signs of trouble in Revlon’s finances? Yes. Thanks to strict disclosure rules for companies listed in the United States, everything we needed was in the public domain. I’ll show you what I look for when considering investing in a business, and it starts with financial statements.

My first stop is always the income statement. This is a very useful part of accounting records, as it will tell me how much revenue the business is generating (aka, top line). This will also give me a measure of the income available to shareholders after costs are paid.

Revlon income statement, source: finance.yahoo.com, author, 2022

When reviewing the financial statements, you should concentrate and avoid being overwhelmed by details. There are two items I tend to look at on the income statement: total income and net income to common shareholders.

Total income measures Operating revenue, or the amount of money a company generates from its main business activities. Note here that we are not considering other sources of income that a business might make; only what it generates from its core business.

Here we see that Revlon experienced a 21% decline in revenue in 2020 as the economy entered the pandemic. This was followed by a 10% increase in 2021 and a further 1% increase in the last twelve months (TTM). Revlon was generating revenue, so what’s the problem? We must go further.

The next post that I usually look at tells us something is wrong. Net Income Ordinary Shareholders tells us how much money Revlon is making to shareholders. Despite the changes to the top line, this post is consistently negative. Not good, because I don’t invest in companies that lose money.

So where are the losses coming from? In these cases, I then look at the balance sheet.

Revlon balance sheet, source finance.yahoo.com, author, 2022

Here it is – Revlon’s total liabilities are far greater than total assets. And looking at tangible book value confirms what we already know; Revlon is worth nothing. Again, this stock is a non-starter for me.

In this article, I described zombie corporations – could Revlon be one of the walking dead? The cash flow statement tells us everything we need to know.

Revlon balance sheet, source finance.yahoo.com, author, 2022

We see that in each accounting period Revlon issues more debt than it pays off. A classic sign of a zombie corporation, Revlon seems to depend on issuing new debt to keep it going. And we really don’t have to look any further to realize that not only was Revlon a bad investment, it was also a zombie company.

So there you have it, a very simple guide to avoiding a bad investment and identifying a Zombie Company. Some analysts estimate that up to 20% of listed companies in the United States are zombies.

Finally, even if Revlon were profitable, updated their business model, and weren’t reliant on debt financing, I probably wouldn’t have invested, for one simple reason: I almost never buy an asset unless it earns me to own it. Shares and property? Give me a dividend or rental income.

I briefly discussed cash flow investing and I urge you to consider it. Although trading is exciting, you CANNOT make money consistently. In fact, multiple academic studies over literally decades tell us that the vast majority of days or short term “traders” lose money.

This is in contrast to what a lot of people on social media are saying, who seem more concerned with selling courses than teaching people. how to invest and generate passive income.

Finally, I note that the Wall Street Bets crowd is discussing Revlon, highlighting the large short position in the stock (we’re not the only ones looking at the financials). Guys I love your work and I will look, but this stock is not for me.


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