HOW AN INVESTOR ANALYSES A BOND
In all aspects of life there is a modus operandi to be followed and this goes without saying in investing. While there is always the option of throwing away your hard earned money in any media hyped stock or bond, the results may not be as good as when you sit down and do your homework on a security before investing in it.
I have covered an overview on how stocks are analysed and this page will look at how bonds are analysed by value investors.
1.First of there is to be the realization that bonds are not for safety [as I have suggested in earlier posts-hey i am also learning ] but investments with limited returns. The investor in essence gives up yield for more safety of hard earned principal. This is because there are also a lot of risk associated with this investment as seen in part of this article.
2.An investor should focus the bond part of his portfolio on bonds with returns higher than high grade bonds(their yields are always very low because the are more or less very safe from default) with a lower risk of loss of principal that is not as high as those of high grade junk bonds. This makes sense to me because it mean that one should also be just as concerned with the returns as with the safety of principal.
3.Avoid companies with a high credit risk. This risk comes from them being inherently unstable (financial, management etc) and having too much debt relative to their income. A combination of these two can erode the margin of safety i.e. the number of times that the interest payments are covered by earnings. This is independent of the size of the company because even a large company with too much debt relative to their cashflow means that they are very much prone to hard financial times during upheavals.
4.when analysing individual bonds there are a lot of things to include in the analysis like the industry that the issuing company is in, the quality of management, the number of times that the interest payments to bond holders are covered with the earnings, financial structure, sources of cash, value of the business and such things should weigh heavily when considering to invest in a bond.
5.The very popular buy and hold method of investing should have no real basis in a value investor and he/she should give the securities a very long hard look from time to time and assess whether they are still fit to hold after reanalyzing all the aspects of bond investing as mentioned above. She must not sell or buy because of market fluctuations or anything that fickle.
6.Market timing must have no place in the investors analysis unless it is favored by all these other factors. What I mean is that if after a fundamental analysis of all the things that are analyzable(what is mentioned above) then he can use market timing to buy the very attractive bonds at a price lower than what he was originally prepared to pay. Market timing should not follow interest rates of other temporary unpredictable things
7. Finally to avoid the inevitability of defaults (when a company cannot pay the interest payments or the principal back to the investors because of financial difficulty meaning that the investors lose everything), he must diversify his bond investing and avoid junk bonds unless his diversification is good enough to handle the danger of default of these very risky issues
Basically this is the M.O. that the value investors follow. In the near future I will revisit this post with figures and everything.
As you can see there is a lot that goes into bond investing just like i showed you with the stock analysis post. And I haven’t even said anything about the analysis of the financial structure of the companies….
(this is the life of a value investor)