Sunday, September 25

Week 12 - AAA stocks and bonds

Situation: Investors have been casting about for “gold standard” investments, i.e., portfolio assets that won’t suddenly collapse in value. This role can be filled through the purchase of AAA bonds issued for sale by four companies, and from several foreign countries.

Goal: To outline investments that add security to your portfolio.

Lately we’ve heard much about AAA bond ratings. And as much as we’d like to find a counterpart among stocks, there isn’t any such equivalent AAA stock. The closest one can come is to own stock in Johnson & Johnson (JNJ). In our previous post entitled Risk (Week 7), we described six ways to assess the risk associated with owning stock in a particular company. Only JNJ came up clean on all six measures. Another endorsement for JNJ came after the Panic of 2008, when a Roundtable Discussion in the 1/12/09 issue of Barron’s focused on the difficulty companies had borrowing money after Lehman Brothers defaulted on September 15, 2008: “Is it going to be harder to borrow money to buy businesses?” Mario Gabelli’s answer was that “it won’t be harder for Johnson and Johnson...” (Barron's 2009 Roundtable, Part One -- Hang on Tight!). The reason JNJ is immune to Creditor’s Disease is that it uses debt sparingly and surrounds itself with a wide “moat”, meaning that for many years it has implemented a strategy that prevents competitors, suppliers, and buyers from defeating its business plan. Johnson & Johnson has the highest-rated or next highest-rated products in most corners of the fragmented health-care market, including pharmaceuticals, medical equipment, over-the-counter drugs, and health-care supplies.  

Four companies issue bonds that are rated AAA by S&P:
   Microsoft (MSFT)
   Exxon Mobil (XOM)
   Johnson & Johnson (JNJ)
   Automatic Data Processing (ADP)

However, Automatic Data Products’ long-term debt is only 0.7% of total equity because its business plan rarely generates enough return on assets to exceed the interest rate it would have to pay for borrowed monies. This means that ADP issues few bonds. Microsoft, a dying monopoly, has tens of billions in cash looking to be used in preparation “for that day”. Since it possesses such a mighty reserve, Microsoft also issues few bonds. Exxon Mobil’s total bond issue amounts to only 10% of equity. Johnson & Johnson issues more bonds, up to 30% of equity. The bonds of all 4 companies are reasonable and safe investments. However, individual investors are at a major disadvantage unless they already possess a lot of wealthy. You have to be able to buy these bonds in multiples of $25,000 or you pay unreasonable transaction costs, which negate the purpose for buying the bonds in the first place. 

The United States no longer has an unambiguous AAA rating on it’s long-term bonds but several countries outside the troubled Eurozone do issue such bonds:  Australia, Canada, Denmark, Norway, Singapore, Sweden, Switzerland, Liechtenstein, the United Kingdom, and Hong Kong. For Americans, Canada is the first place to shop for AAA sovereign credits. Fixed-income analysts also have a high opinion of those issued by Norway, Australia, and Singapore. For investors with limited capital, it is not reasonable to try owning sovereign credits other than those issued by the US Treasury, which are available cost-free in $100 lots at While 30-yr Treasury bonds have been downgraded by S&P to AA+, shorter duration issues retain the AAA rating: 10-yr Treasury notes represent a safe and rewarding investment for those who are prudent and employ dollar-cost averaging and re-invest interest payments. More importantly, 30-yr Treasury bonds are likely to regain their AAA rating soon. Why? Because fiscal policy (controlled by Congress) and monetary policy (controlled by the Federal Reserve Board) no longer promote deeper indebtedness as a means of “jump starting” the economy. In other words, “strong dollar” policies have replaced “weak dollar” policies. We alone, among major economies, are stopping the expansion of government and central bank balance sheets. 

Bottom Line: For investors looking to buy corporate bonds rated AAA by S&P, choices are pretty much limited to those issued by Johnson & Johnson and Exxon Mobil. Sovereign bonds of Australia, Norway, Singapore and Canada are also safe investments, as well as 10-yr US Treasury notes. While stocks in general are 4-5 times more risky than investment-grade bonds, the bonds issued by Johnson & Johnson, Exxon Mobil, and Automatic Data Processing are remarkably stable and worthwhile investments because they pay a high and growing dividend and carry no risk of bankruptcy, hence the AAA bond rating.

<to continue to Week 13 click here>

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