Creditors vs. Stockholders

If you own a bond - you are lending money to the issuer. You are mostly concerned about the company’s ability to repay your principal and make your interest payments on time. Your perspective as a bondholder is very different to that of a stockholder. Today we highlight the differences.

Some Stockholders like to see robust dividend payments and share buybacks. This puts more money in the pocket of shareholders. In contrast, higher dividend payouts and stock buybacks are generally less attractive to bondholders, because it means less profits are retained in the company and the buffer between free cash flow and debt repayments becomes lower. The higher the “buffer” between free cash flow and debt repayments, the lower the risk to the lenders. Bondholders favour companies with conservative dividend payment policies. Stockholders who like steady dividend payments should look to utility companies and real estate investment trusts (although cautiously in the current environment) - companies with steady revenue and predictable capital expenditure requirements. Banks generally do not fall into this category. Banks are subject to a wide variety of regulatory and accounting rules that require them to meet a series of targets before paying out dividends. Beyond that, banks must adopt an extra layer of fiscal conservatism to navigate unexpected (or anticipated) changes in the economic environment. Notwithstanding the inherent volatility of the business, banks can be an attractive source of dividend income and share buybacks. This, however, will vary with the economic environment, and to a lesser extent, the ownership structure and management.

On the flip side of the equation, there are some shareholders who will sacrifice dividends (e.g., most tech stockholders) in favour of reinvesting profits in new technologies, new business lines or to add scale to the business. These stockholders want the company to invest in future growth and will sacrifice current income (i.e., dividends or stock buybacks). Growth oriented stockholders generally don’t like to see a business selling assets or keeping cash on hand – because they want the company to invest the funds in higher yielding or higher growth activities. In contrast, bondholders are generally happy when a company moves from illiquid, unproductive assets to cash. Many large companies have experienced credit rating upgrades by simply selling excess real estate, scaling down their dividends and rationalizing the size of their business. Selling non-core assets is a credit positive and generally is a move that bondholders would welcome. As a bondholder, you care about free cash flow and management’s capacity to generate sustainable levels of it.

Whether you like or dislike a dividend policy or a business strategy, is usually dependent on whether you are a bondholder or a stockholder. When reading the news, it is important to remember where the majority of your interests are aligned.

Marian Ross is Vice President, Trading & Investment at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm 

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