Investor Education Centre > Corporate Bonds > Finding the Best Corporate Bonds: What to Look Out For
Finding the Best Corporate Bonds: What to Look Out For
Corporate bonds are a special breed of fixed income products. Unlike government bonds, corporate bonds aren’t backed by the weight and history of the government, nor are they insured. Despite this though, there are advantages that come with investing in corporate bonds over government options (such as generally higher returns), provided investors do their research and choose the right companies. When it comes to selecting companies to purchase bonds from, it helps to consider the 4 C’s of bond analysis.
1) What is the character of the company’s leadership team?
When considering which companies to invest in, it’s always important to look at the company’s leadership, and the strategy they’ve set for the future. Do they have a clear vision for how they’ll continue to remain competitive in the market? Are the individuals leading the company trustworthy and free of public relations turmoil?
Companies that have a strong leadership team generally make safer targets for purchasing bonds from, all other things being equal.
2) What is the company’s capacity to pay off its debt?
Will the company be able to meet its debt obligations on a go-forwarded basis, or are they a stiff breeze away from folding like a house of cards? One of the more popular ways of determining this is by looking at the company’s debt as a ratio against its annual earnings; in general, the lower that ratio, the better, though the ratio that is considered the 'right' figure varies widely depending on the company, industry, and other factors.
Another useful metric is to compare the company’s total annual interest payments against its annual earnings; at the bare minimum, the company’s earnings should be greater than its required annual interest payments. Otherwise, where do you expect to receive payment from?
3) What collateral has the company put up to back its obligations?
Companies sometimes offer collateral as an extra assurance to bond investors that they will repay their debts. This collateral can take the form of land, shares in a subsidiary company, or other such guarantees.
Collateral-backed bonds are especially important if you’re purchasing what are known as high-yield (or 'junk') bonds, which are bonds that are classified as riskier than what are known as 'investment-grade' bonds. While a company’s bondholders are entitled to receive payouts before its shareholders in the event of a default, bondholders are still at risk of not recovering their full investment, should the company find itself in financial trouble. Collateral against those bonds offers an extra level of assurance that the investment will be recovered in that event.
4) What are the conditions in which the company operates?
While the other three C’s consider internal factors about the company in question, this one focuses on external factors that might affect the company’s ability to repay its loans. For example, how stable is the economic environment in which the company operates? How subject to fluctuations in customer purchasing behaviour is the company? Are there any political risks associated with the countries in which the company conducts its business? These are all aspects of the external environmental conditions that should influence your decision to purchase bonds from a company.
Corporate bonds come in all shapes and sizes, from relatively low-risk and lower-yield, to higher-risk, higher-reward. Selecting the right companies to invest in takes planning and research, but the effort will pay dividends in the future. With these tips, you’ll be well on your way to making more informed bond purchase decisions.
This website contains general information only and is not intended to provide any person with financial advice. It does not take into account any person's (or class of persons) investment objectives, financial situation or particular needs, and should not be used as the basis for making investments.