After Identifying A Good Company, Should You Consider Investing In Its Stocks Or Bonds (Or Both)?
This article was written in collaboration with the Fixed Income Conference organised by SIAS. The event will be held on 24 August at Suntec Singapore Convention. You may register for the event here. Any views expressed in this article are the independent opinion of DollarsAndSense.
Most of us understand the basic need to invest our money, to grow a nest egg that will beat inflation in the long-run and provide for us in our retirement. However, before making an investment, we owe it to ourselves to make the right decisions.
This is because 1) we’ve worked really hard for our money, and 2) the investments we make will be going towards an incredibly important purpose – our retirement. The majority of us simply cannot afford to squander our savings.
One of the simplest and quickest ways we can build our investment knowledge is to read personal finance articles (like this one), speak to our family and friends who are already investing and attend finance events to hear from investment professionals share their valuable insights.
One upcoming event you can head down to is the Fixed Income Conference, organised by the Securities Investment Association Singapore (SIAS), and supported by the Singapore Exchange (SGX) and MoneySense, Singapore’s national financial education programme. It will be held on 24 August 2019 (Saturday), from 1.00 pm to 5.30 pm. Admission is free but you will need to pre-register via this link on the SGX academy website.
Investing In A Good Company
It would be a huge understatement to suggest that as investors, we naturally want to invest in good companies, and to avoid bad ones.
However, after identifying a good company, we need to ask ourselves why we think that company is good. The answer we get to this question would lead us to the next question – should we invest in the company’s stocks or bonds?
To help answer this question, here are 3 factors we should be considering.
# 1 Building A Well-Balanced Portfolio – With The Right Asset Allocation Strategy
Newer investors may think that a well-balanced portfolio would comprise of a diversified range of stocks. This is to mitigate unsystematic risks, also known as diversifiable risk, where the poor performance of one company, sector or region, adversely affects the entire portfolio.
A well-balanced portfolio is not just about ensuring it is sufficiently diversified with a broad range of stocks. We also need to spread our investments into different types of assets – mainly comprising of stocks and bonds when we describe investing, but assets can also include properties, commodities and cash.
A good asset allocation strategy should take into consideration 2 things – your risk appetite and investment horizon.
Whether we invest in stocks or bonds, all investments come with some degree of risk. Our risk appetite is our ability to stomach investment losses in exchange for higher expected returns.
Generally, stocks are considered the riskiest asset class. In investing, the greater the risk we take, the higher the return we should expect, and stocks have also been known to generate the highest returns. On the flipside, the greater the risk we take, the higher the probability that our investments would turn south, and that we may receive lower returns than we initially expected or even suffer losses.
Bonds are generally considered less risky investments. This is because companies are obliged to pay out the promised coupons and the principal amount borrowed, regardless of whether they make a profit or loss, unless they are in an insolvency situation. The big question, though, is if the company is likely to default?
In the event that a company is unable to repay its obliged bond payment and ends up being wound up (an unlikely event), bondholders will have a priority claim over shareholders on the assets of the company. Do note however that bondholders are also unlikely to be the only people who are owe money from the company, and that there could be other creditors who have equal or higher claims to the assets of the companies compared to bondholders.
Bonds which are issued can have a wide range of maturity. This could be from one year to as long as 10 years or more. While market volatility does not impact your principal amount and coupon payments, if you need to sell your bonds on the secondary market (e.g. SGX) before maturity, you may suffer a loss if the market value of the bonds are lower than the original amount which you bought the bonds for.
This means that if we need our invested funds for a home renovation project in two years, we should be taking much lower risk with our funds as compared to if we required it for our retirement in three decades.
At the Fixed Income Conference, Mr Christopher Tan, Executive Director of MoneyOwl, and CEO of Providend, will be covering on how fixed income products, such as bonds, can be part of your portfolio.
# 2 Do You Like A Company’s Growth Prospect Or Its Cashflow Stability?
We often hear our peers commenting that “investing in a blue-chip stock is one of the safest ways to invest.” While there is some truth in that statement, we should ask ourselves an additional question before investing in it – what do we like about the company?
Is it because the company is offering great products and/or services with a bright growth trajectory (perhaps they can quickly expand overseas over the next few years and increase their profitability), or the fact that it has a solid business with a stable cashflow that will be around for the next few decades.
We’re sure you know where this is heading by now.
If a company has a really bright outlook in terms of growth, you would want to ride along with its growth, as it will likely have a positive impact on its share price. If a company has a business that you don’t think anyone can compete with for the foreseeable future, but are not too excited with its ability to grow its market share or roll out a great new product, you may actually be more interested in investing in its bonds.
For example, if we roll 5 years back in time, and thought that the banking industry was poised for growth on the back of a global recovery, we may have invested in its shares. If we invested in DBS 5 years ago, we would have enjoyed a share price appreciation of close to 38% AND a dividend payout over the years of nearly $5.01 or 28% of its share price in 2015. In total, we would have enjoyed 66% in total returns over the last 5 years. (DBS’ share price 5 years ago (on 22 August 2014) was $17.93. DBS’ share price today (on 16 August 2019) was $24.70. DBS paid out $5.01 in dividends since 13 August 2014.)
In comparison, if we had really liked Frasers Property’s business 5 years ago, but thought that the real estate industry was a really competitive one, investing in its stocks would have delivered us a return of share price appreciation of nearly 2%. After adding its dividend distribution of $0.43 cents or close to 25% in that timespan, our total return would have amounted to close to 27%. (Frasers Property’s share price 5 years ago (on 22 August 2014) was $1.7. Frasers Property’s share price today (on 16 August 2019) was $1.74.)
Certain companies, like Frasers Property, have related retail bonds that are listed on the SGX as well. This means investors like us can buy its bonds, similar to the process of buying its shares. If we had invested into Frasers Property Treasury bond (FPTrea b3.65%220522) when it was listed on 25 May 2015, we would have earned a coupon of 3.65% each year, without incurring any uncertainties in the amount we would receive. Its bond price is trading at 1.5% above its issue price as well.
While it may look like we would still have been better off investing in stocks, we need to note that bond investors did not have to ride Frasers Property share prices down to $1.49 when it dived, and they also missed out on its share prices soaring to $2.20 at its peak. In addition, while all banks had experienced share price appreciation in that time, property companies, large or small, encountered greatly differing fortunes.
In the same period, another large real estate company like City Development Limited (CDL) had seen its share prices decline 11%, while paying out close to 10% in dividends.
Bonds provide fixed income, via its coupon payments. This could be one aspect of bond investing that would be attractive to some investors, particularly if you are looking at a strong, stable business with predictable cashflow.
If you want to find out more about investing in bonds, study the information from bond issuers SIA, as well as from Temasek and Azalea Asset Management (who recently launched the Astrea IV and Astrea V PE Bonds), who will be making presentations at the Fixed Income Conference. (They are not marketing any bonds at the event though.)
# 3 Risk VS Reward
Another thing we have to consider is the risk-reward trade-off. This is something that was somewhat alluded to in the above argument as well. We noted that while an investment in Frasers Property’s stock would have led to a better outcome than investing in its related bonds, shareholders would have faced a volatile ride in the 5 year investment period.
Similarly, we can look at one of the most recent bond issues, from SIA (SIA 3.03% 240328) on 29 March 2019. Since then, if we had invested in SIA’s shares, we would have experienced a great deal of volatility, with share prices declining from $9.66 to $8.94. In the same time, its bonds prices have actually increase 2.5%, and will continue to pay 3.03% in coupons.
The Fixed Income Conference will also end off by bringing together all the experts in an interesting panel discussion on how investors can use fixed income as a strategy to build their wealth. This can be a great opportunity for investors to listen to the problems other people have. You can attend the event and ask your own questions if you have doubts. Alternatively, if you have a question that you wish to ask, DollarsAndSense will be at the event. So just leave your questions on the comments section on this Facebook post and we will ask it on your behalf!
Always Question Every Piece Of Advice Or Strategy Before Implementing It
When we speak to most financial professionals, they have a view and are willing to share it, but are always quick to point out that we should do our own due diligence. Those of you who frequent forums and online portals will see this acronym DYODD, which basically means that you need to be accountable for your own decisions.
One big question we cannot ignore when discussing bonds is that simply investing in bonds does not mean they are safer. In recent times, we have also seen several issuers defaulting. These include both smaller companies and high-profile names such as Hyflux and Ezion.
Before we invest in a bond, we need to ask similar questions to investing in stocks – is it a safe investment, can it maintain its business stability over the time frame till the bond matures and others.
Attend the Fixed Income Conference to find out more about creating a strong bond portfolio and clarifying any doubts you may have.
The post After Identifying A Good Company, Should You Consider Investing In Its Stocks Or Bonds (Or Both)? appeared first on DollarsAndSense.sg.