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Don't Get on the Other Side of This Trade

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Every time you make an investment, there's someone else on the other side of the trade you make. And when you boil down investing to its lowest common denominator, what it comes down to is this: No matter how smart you may think you are in how you invest your money, whoever's selling that investment to you thinks you're dead wrong. That's why you should look at some recent offerings from smart corporations with skepticism.

A dog-eat-dog world
Not every investment has to have a winner and a loser. In some cases, both parties get what they want. For instance, any time a company goes public, buyers get the chance to participate in a new business opportunity, while those who created the business have a chance to sell part of their stake and diversify their financial exposure -- often while still retaining the lion's share of their stock holdings for future profit.

But sometimes, it's more evident that one side has the better end of the deal. Take, for instance, the recent onslaught of corporate bond issuance. As the European crisis has once again pushed yields on 10-year Treasury notes near the 2% level, opportunistic companies are taking advantage of another chance to lock in favorable financing. Here are just a few of the takers:

  • UnitedHealth (NYSE: UNH  ) issued $1.25 billion in bonds with maturities ranging from five to 30 years.
  • Dr Pepper Snapple followed suit with $500 million in seven- and 10-year bonds.
  • Amgen (Nasdaq: AMGN  ) is looking to sell $6 billion in debt, despite the fact that the move prompted bond rating agency Fitch to downgrade Amgen's bonds to BBB.
  • Last week, Sprint Nextel (NYSE: S  ) borrowed $4 billion on the credit markets, with the junk-rated mobile company paying yields of 9% on its seven-year bonds and 11.5% on 10-year debt. Dow Chemical (NYSE: DOW  ) also took advantage of low rates to raise $2 billion in 10- and 30-year bonds.

Perhaps the most interesting of these deals is Amgen's bond offering. The biotech giant specifically wants to repurchase stock with the proceeds from its debt issuance, effectively adding leverage to its balance sheet. The move suggests that the company thinks that its bonds are overpriced in comparison to its shares. So that raises the obvious question: If Amgen thinks its stock is a better buy than its bonds, why should you take the other side of that trade by buying the bonds it's offering?

Desperate times
The problem that many investors face is that with yields at ultra-low levels, you can't always get as much income as you need from the fixed-income side of your portfolio. For years now, income-hungry investors have faced two equally troubling choices: Take on more default risk with lower-quality bonds, or increase exposure to dividend-paying stocks that generate more income but come with more price volatility.

For all that people have good things to say about dividend stocks, they definitely don't give you the same security of principal that you get from bonds. Several stocks that pay dividends, including Hudson City Bancorp (Nasdaq: HCBK  ) , Veolia Environnement (NYSE: VE  ) , and Teekay Tankers (NYSE: TNK  ) , have lost half or more of their share value in the past year. Although the yields cushioned the blow to a very minor extent, those losses are no less real -- and retirees can ill afford to suffer them.

With bonds, though, your upside is strictly defined -- you know for certain that you'll never get any more than the interest payments plus your principal back, and that's assuming all goes well. When low interest rates mean that you have to take on big risks of losing principal from default, then you aren't getting the reward you deserve for accepting the limited upside that bonds offer.

Make the right move
Corporate bond issuance makes it very clear that companies believe they need to take advantage of the good times for debt financing while they last. You don't need to be on the other side of that trade. Whether you go with dividend stocks or choose to stay in cash, you'll almost certainly be better off avoiding low-paying corporates.

Dividend stocks aren't a replacement for bonds, but they can still make a big difference to the stock side of your portfolio. Thousands of Fools have already discovered 11 smart dividend picks for your portfolio in our new free special report; it's just a click away, so why wait?

Fool contributor Dan Caplinger doesn't always pick the right side, but he always picks someone. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of UnitedHealth Group. Motley Fool newsletter services have recommended buying shares of UnitedHealth Group and Veolia Environnement, as well as creating a diagonal call position in UnitedHealth Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is always on your side.


Read/Post Comments (2) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 08, 2011, at 2:27 PM, kirkydu wrote:

    Veolia (VE) at least, imho, is a screaming buy now precisely because it has gotten hammered. The other two that have lost merit more research from what I can tell.

  • Report this Comment On November 10, 2011, at 5:21 PM, frank3773 wrote:

    Teekay Tankers does not pay a "dividend" - it's "return of capital" - 100% for 2010, and for 2011 it will be determined at end of year what part may be designated dividend/return of capital. Different tax treatment?? And, "ROC" lowers your cost basis if/when you sell shares.....

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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