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corporate finance

Matt Rourke

Some top-rated U.S. companies have turned traditional corporate finance practice on its head, and are now offering greater yields on their stocks than on their bonds.

The trend could signal a buying opportunity in stocks. Income investors, in particular, can now reap a higher yield by buying some blue-chip shares than by investing in bonds of the same companies - a reversal of the norm that has held for decades.

In August, Johnson & Johnson raised $1.1-billion (U.S.) in a debt sale. The yield on the 10-year bonds came with a coupon of just 2.95 per cent, which Citigroup Inc. labelled as the lowest corporate coupon rate for that duration on record, dating back to 1981. In comparison, the pharmaceutical giant's stock is paying an annual dividend of 3.5 per cent.

Last week, Microsoft Corp. raised $4.75-billion with three bond-offerings at some of the lowest rates in history. The three-year notes yield less than 1 per cent, the five-year yield 1.7 per cent and the 10-year offer 3.1 per cent. That compares with a 2.5 per cent annual yield on the company's shares.

Dividend yields and bond yields aren't exact equivalents, because equity investors run the risk that share prices will fall. But if prices for J&J and Microsoft shares do nothing more than remain stable over the next few years, shareholders will do better than bondholders.

Investors are shying away from equities because of uncertainty over the economic recovery. At the same time, record low interest rates are luring corporations into the debt market, even if, like cash-rich Microsoft, they have no immediate need for money.

The Rally Is Over

Some commentators see the entry of such companies into the fixed-income market as evidence that the recent stampede into bonds has gone too far.

"When companies such as J&J and Microsoft issue bonds, you know the bond rally is over," says Hank Cunningham, fixed income strategist at Odlum Brown Ltd. and author of In Your Best Interest: the Ultimate Guide to the Canadian Bond Market. "It says that money is too cheap."

Bond yields have tumbled as investors have rushed into bonds in pursuit of safety. Canadians, for example, have put $10.8-billion (Canadian) into Canadian bond funds over the last year, while withdrawing a net $2.1-billion and $4.7-billion from Canadian and foreign equity funds, respectively, says Murray Leith, director of investment research at Odlum Brown. He thinks a herd mentality has overtaken common sense.

In his October newsletter he writes: "With Canadian 10-year government bonds and high quality corporate bonds currently yielding less than 3 per cent and 4 per cent, respectively, it is a mathematical certainty that the average Canadian bond fund will not achieve a compound annual return of 5 per cent over the next 10 years. Conversely, returns from stocks in the decade ahead are likely to be much better than they were over the last 10 years, because the lack of demand has rendered prices very attractive."

Both Johnson & Johnson and Microsoft garner triple-A rating status from the bond rating agencies. Together with Exxon Mobil Corp. and Automatic Data Processing Inc., they are the only four non-financial companies to enjoy the same credit rating assigned to U.S. government debt. Their triple-A ratings insure that they receive the best corporate lending rates in the market.

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