I often get criticized for equating stocks to bonds. Truth of the matter is that I never equate them, but often-times compare them. I’ll say it up front — common stocks are not bonds!
In a recent article, I termed AT&T Inc. stock “a low-investment grade bond with an inflationary kicker.” This irritated some readers who seemed to think I was off my rocker for saying such a thing. What was I really saying?
AT&T, like many telecom and utility companies, has a customer base from which it receives a large portion of its revenue on a recurring basis. Since these revenues are unlikely to rocket to the moon or fall off the face of the earth anytime soon, AT&T’s cash flows are somewhat predictable. Most bonds have an exacting recurring revenue component — one in which a predetermined amount must be paid to creditors on a clearly spelled-out calendar basis. From that perspective I consider AT&T “bond-like.”
Today AT&T Inc. yields more than 5.5 percent, which places it amongst the top tier of large-cap companies that pay a dividend. To get 5.5 percent in the investment-grade bond market, you either need to go pretty far out on the yield curve or, for something shorter, you’ll probably be looking at something in the energy or commodities patch. Either might not be a particularly comfortable proposition for the conservative investor.
Stocks, in general, given their lack of a contractual guarantee, place capital at risk much more so than a bond. Taken together, I believe AT&T common stock yielding 5.5% is a comparable, but not exacting, risk to what one might be taking in an investment grade bond of lower quality or longer duration.
One of the benefits of a common stock, however, is the possibility for growth, both in capital via stock price appreciation and via dividend growth. AT&T’s dividend growth has been very slow — in the 2-3% range recently. It has been inflation-like — the inflationary “kicker” I noted above.
What Other Kinds Of Businesses May Be Deemed Bond-Like
It’s probably a bit too liberal to say that any company with recurring, predictable revenue from same or similar sources might be considered bond-like. Right now someone might look at Apple that way. There are those that stand in line to get the newest iPhone upgrade every time one is available. If one is of the belief that this continues infinitum, then maybe they’d be correct. I don’t consider this likely, however. There’s really nothing all that predictable or certain about the technology sector.
What is likely, longer-term, is that electricity will need to be supplied to both homes and businesses, water will need to run through plumbing lines, and we’ll all need toilet paper until the day we die. Utilities focused on the supply side — the line into the home as it were — would have bond-like recurring revenue. There are certain consumer products companies one might argue as utility-like. Although, it may be a stretch to do so.
Real estate leasing may be another area where bond-like cash flows are seen. Many REITs (real estate investment trusts) write long-term deals with tenants that lock-in a very predictable level of cash flow. Investors researching REITs should understand the credit quality of those who inhabit the trust’s property. Some REITs lease primarily to investment grade clientele, while others are a bit more liberal in hopes of generating a higher level of property level operating income.
Some may consider the revenue of certain types of health care companies as predictable. Health care, while certainly a necessity, has many players jockeying for a piece of the revenue pie at all times. Doctors, insurance companies, hospitals, pharmacies, drug companies themselves, and a host of other players are constantly involved. Patent expiration, changing government reimbursement, and technological innovation change the healthcare landscape on a daily basis.
Though recurring, healthcare revenues are highly variable and really unpredictable. I don’t think one can look to healthcare as a “bond-like” space.
At the end of the day, whether a business is considered bond-like or not, an investor must drill down to understand where revenue is coming from and whether it is likely to continue or not. Those without much risk tolerance should be looking at investments with forward predictability involved. If you don’t have a high level of confidence or conviction in the control a company has over its current and forward cash flow, you should consider it generally of higher risk compared to a company in which you do.
