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Stocks v. Bonds

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May 26, 2011 – Comments (5)

Stocks or bonds?  Which is the best choice for income?

This article compares the yields on bonds with ~10 years to maturity to the dividend yield from the issuing company.  At current prices, most of these companies could theoretically issue ten-year paper, use the money for share buybacks and actually improve their cash flows - the coupon payments on the bonds would be less than the dividend payments on the stock after taxes.  In my opinion, that situation makes the stocks a much better deal than the bonds from the same companies even considering the different risk profiles.

As always, comments welcome.  Even / especially if you disagree.

Fool on!

Russ

 

 

5 Comments – Post Your Own

#1) On May 27, 2011 at 9:15 AM, lemoneater (69.98) wrote:

I will admit my ignorance of bonds. We have some in our retirement fund through our company, but I don't have any in the portifolio I actively manage.

Remind me, aren't bonds ownership of the loans to a company or municipality, while shares are actually direct ownership of a company. You don't vote bonds, right?

Ideally, stocks pay you in two ways: share price appreciation and dividends. Do bonds experience as much price appreciation as stocks can or are they less volatile? I've heard of junk bonds, but never penny bonds. Do bonds have IPOs which generate a lot of excitement: love, hate, etc?

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#2) On May 27, 2011 at 6:08 PM, ikkyu2 (99.22) wrote:

Worth noting that if a company were to issue bonds for the purpose of retiring dividend-paying shares, shareholders who didn't sell would benefit from share price appreciation/owning a larger fraction of the resulting company, without having to do anything else.  So that would make those stocks an even better deal.

The best performing investment in my portfolio over the last 6 years has been the Fidelity Capital and Income junk bond fund, ticker FAGIX.  It has dollar cost averaging built in as it throws off a monthly payment which I reinvest.  I certainly feel like if you're trying to invest in corporate debt at any quality level, you do well to diversify, which for most retail schmoes like us means an actively managed fund. 

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#3) On May 27, 2011 at 6:45 PM, rd80 (97.59) wrote:

@ lemoneater, 

aren't bonds ownership of the loans to a company or municipality, while shares are actually direct ownership of a company. You don't vote bonds, right?

Correct.  Bonds are a slice of a loan.  They come in many different flavors - long term, short term, variable rate, fixed, callable, junk, high quality...  Bondholders don't have have an ownership interest or voting rights - unless the company defaults, and that brings a whole new dynamic to the trade.

Do bonds experience as much price appreciation as stocks can or are they less volatile?

Bonds typically are less volatile than stocks, but it varies.  Bonds make money for investors in two ways - the coupon, or interest payment, and price appreciation.  Prices rise (or fall) if interest rates drop or credit quality improves.  Hypothetical - if you hold a bond with a 5% coupon rate and rates fall to 4%, your bond's price goes up.  If you hold a junk bond and the issuer's business improves to where the bond gets rerated to investment grade, the price goes up.  

Do bonds have IPOs which generate a lot of excitement: love, hate, etc?

A new bond issue is similar to an IPO, but doesn't typically get the press and excitement of a stock IPO.  Maybe because, as ikkyu2 notes, most retail investors own corporate bonds via funds and bonds don't have the roadshow and big bell ringing deal at the exchange.

FINRA.org has a pretty good rundown on bonds and the various flavors available.

@ ikkyu2,

Yep, the 'borrow to buyback share' trade seems like it would make sense for companies that can issue debt at cheap rates, at least until the company bid the stock price up or put the credit rating in jeopardy.

 

 

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#4) On May 27, 2011 at 11:13 PM, checklist34 (99.71) wrote:

GREAT post, and a GREAT point. 

rec

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#5) On May 31, 2011 at 7:59 AM, lemoneater (69.98) wrote:

Thanks very much for yet another helpful article and blog. I went to the Finra.org web site and found it quite understandable. You are very gifted at demystifying financial things, Russ. Hope that you had a great Memorial Day and that you have a good week.

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