In this post I discuss four bonds for the average income investor to consider.
Interest rates are tough to predict. Far smarter people than I have made fools of themselves trying to predict interest rates. As you know bond values vary as interest rates vary. When interest rates go up the value of a bond goes down and vice versa. Provided that you buy your bonds at par or less, and hold them to maturity, these price variations are insignificant.
If you trade bonds, opportunities are abundant when interest rates are volatile, but we income investors do not trade bonds. We invest in bonds to diversify our portfolio with an income instrument that is highly likely to deliver a steady source of income from interest and return our principle when the bond matures. If you are a savvy bond investor you might even secure a capital gain if you bought your bond at a discount to par and receive par upon maturity or redemption.
Morningstar manages the bond data for Financial Industry Regulatory Authority (FINRA.) I use their site to search for bonds and then I look to my broker, I use Charles Schwab, to actually find the bond's availability and trading price.
Bonds differ from stocks in that they are not as liquid. You do not have a platform where you can place a limit order on a website and check in at the end of the day. You need to have all your data at hand and make your decision to buy at the time the order is placed. Schwab allows some bonds to be traded through their website but not all. A call to the bond desk can provide better access to an acceptable trade.
Bonds also differ from stocks as you receive interest income for every day you own a bond. Whereas with a dividend stock, you must own it on the ex-dividend date to receive the dividend. You receive no income if you sell the stock prior to the ex-dividend date.
Interest Coverage Ratio
I have discussed D/E (debt to equity ratio) many times over the past years. I have not discussed interest coverage ratio as much. Interest coverage ratio is calculated by dividing EBIT which is earnings before interest and taxes by interest expense. You can find this ratio already calculated for you on several websites but you can also go to the financial statements and find the data so that you can calculate it yourself.
Interest coverage ratios of greater than 2 are what you want.
Four Interesting Bonds
ADT Corp, symbol ADT, has a bond that matures in 2023. Alcoa, symbol AA, has a bond that matures in 2024. Boise Cascade, symbol BCC, has a bond that matures in 2020 and Embraer, symbol ERJ, has a bond that matures in 2022.
I like to ladder my bonds by maturity. The table below presents these bonds by maturity. It includes the coupon, recent price, and yield to maturity. Laddering takes some of the interest rate risk out of the equation. These four bonds mature in 4 to 8 years. Interest rates could be exactly the same or much higher in 8 years. Although I would get my money back at maturity, I might have lost income opportunity if a 5 year U.S. Treasury is paying 6%.
A U.S. Treasury bond is safer than any of the four bonds profiled here. So I would not want to commit my money for much more than 5-7 years.
The Table below lists these four bonds by maturity.
A bond is only as good as the company that backs it. I look for a stock with earnings, reasonable D/E ratio (debt to equity ratio), and decent interest coverage ratio.
The next table presents the issuer fundamentals including the CUSIP number for each of the bonds I may buy this week.
ADT Corp. (ADT) has a thriving business. They have earnings, pay a dividend and have revenues that are increasing; all good metrics. However, their debt load is a bit heavy and that will way on my decision.
Alcoa (AA) is in an industry that is under enormous pressure right now. Although if you just look at D/E ratio, MSN Money ranks their D/E ratio at .75. One of the peculiarities of their financial reporting is an interest coverage ratio of 1.5. This is hard to believe as they had negative EPS during their latest quarter. Looking back further earnings are all over the place. Will commodity stocks like Alcoa come back? Probably but the buyer of their bonds must understand there is risk and that is why the bond is trading at a discount.
Boise Cascade (BCC) is the most solid of the stocks noted here. Boise has solid revenue growth and reasonably good earnings although their most recent quarter showed some erosion in earnings. The stock has a solid D/E ratio of .64 and interest coverage ratio of 4.58. This is why BCC is trading right around par. This is my favorite bond here, provided I can buy it at par or less.
Embraer (ERJ) is a Brazilian company that trades in the US and follows most of our accounting rules. D/E ratio of Embraer according to MSN Money is .94 which is respectable for a stock that requires a lot of capital. Interest coverage ratio is hard to measure as their financials show no interest payments. These facts may be suspicious and therefore I will probably not buy the Embraer bond unless I can get it at a significant discount.
Consider one or more of these bonds for the income producing portion of your porftolio.
Disclosure: May buy the ADT, AA, or BCC bond this week.