Corporate Investment Analysis

Investment Analysis There is a significant difference between bonds and stocks, and they should not be treated the same when evaluating a portfolio. There are a handful of similarities, such as the fact that their value derives from the net present value of expected future cash flows, but the two securities are fundamentally different. A bond entitles the holder to a cash flow from the issuer. Equity represents a share of ownership in the company. From this arises the first key difference -- the risk.

Risk refers to the chance that the expected cash flows will be disrupted. With equity, this means that the earnings could drop, reducing not only the dividend but also the future profit potential as well. The value of the company's cash flows is likely to change if the company's performance suffers a downturn. With a bond, the only risk is the risk of default. Default typically will not occur except in the event of bankruptcy. Therefore, there is a low risk of default with most companies.

If the issuer's performance suffers, this will not necessarily result in an increased risk of default. The second major difference between bonds and equities is with respect to the issuer. Bonds can be issued not only by corporations but by governments as well. This gives the investor a wider range of options with respect to issuers. Treasure bonds are considered to be no risk, and most other government bonds are considered to be low risk.

As we have seen with equities, in particular the collapse of even major corporations, that degree of safety simply does not exist with equities. The value of equities tends to fluctuate based on recent earnings trends. For the most part, interest rates are not a major factor, other than in the contribution they make to the discount rate. Bonds, on the other hand, are subject to significant fluctuation based on the changes to the interest rate.

Interest rate changes affect the yield a bond needs to offer to entice investors, and this in turn is reflected in the price. Therefore, the price of bonds is impacted by interest rates to a much larger degree than the price of equities. Another difference is that with equities, you receive ownership. This comes with voting rights, which gives the shareholder a voice in how the company is governed. The shareholder can select board members, who in turn manage the executives. Bond holders do not have such privileges.

Another perk of ownership is that equity holders will earn substantial gains if a company that they hold is taken over. Takeovers a wild card in investing, but can provide a strong one-time gain for an equity holder. Bond holders do not gain from takeovers, they merely have their payments made as always. Another potential difference is with respect to liquidity. The market for most equities is highly liquid. Investors can trade equities directly on the market. Investors do not typically trade bonds on the market,.