To Win in Stocks, You Must Understand Credit

Equity investors don't tend to think much about bonds...

After all, stockholders are the low man on the totem pole. All the value these folks are obsessed with – like market cap, net income, and dividends – is left over after creditors have taken their pound of flesh from the company.

But keep in mind that both stocks and bonds are just extensions of a company's cash flows. It's all a question of how you divide up those cash flows.

Bondholders get first dibs. So as a stockholder, if you don't pay attention to the bond markets, you could miss big warning signs. If a lot of companies are caught with debt coming due right when the credit market tightens, that's how you know we're going to face bankruptcies and a recession.

And when lenders are making it easy to access loans, corporations are able to refinance and invest in the future. It's an "all clear" signal to be bullish on the economy and the markets.

When Altimetry founder Joel Litman and I worked at Credit Suisse, we were always shocked by how walled off the equity and credit divisions were. More than once, we tried to bring together two analysts who covered the bonds and stock of the same company... and they'd refuse to sit in the same room.

That's why, when Joel and I first built our institutional business back in 2009, we committed to doing both stock and bond analysis. We knew these analysts were doing themselves a disservice by keeping their research separate.

And as we'll discuss today, this lesson applies to everyday investors. You're doing yourself a disservice if you don't understand credit – even if you're only buying stocks.

In 2009, we told our hedge-fund clients to go long on airline and hotel stocks...

It turned out to be a great call. Within a few years, shares of air carriers JetBlue Airways (JBLU) and Delta Air Lines (DAL) were up 296% and 345%, respectively. Hotel chain Starwood doubled.

But here's the secret... We didn't find this opportunity by looking at earnings calls or profit potential.

We found it through the credit market.

We could see that the bond market was treating many of these airlines and hotel chains like they were at risk of going bankrupt. And our analysis showed that just wasn't the case.

These companies had plenty of cash to handle their debts with no issues. And we knew once the market recognized that, their stocks would take off.

When you know how to check a company's credit health, you have another tool at your disposal for finding cheap, misunderstood stocks... or avoiding potential portfolio torpedoes.

A lot of investors can't say that.

If you have any money in stocks, one of your first steps should be to check every company's credit health.

By doing this at the end of 2021, you could easily have predicted which stocks would fall the most over the next two years.

Take a look at the following list. It shows the five riskiest companies, based on credit health, with market caps of $10 billion or more at the start of 2022...

• Royal Caribbean Cruises (RCL) – up 20% since then

• American Airlines (AAL) – down 29%

• Carnival (CCL) – down 32%

• Carvana (CVNA) – down 82%

• AMC Entertainment (AMC) – down an incredible 97% since then

As you can see, of the five riskiest companies, only cruise-line operator Royal Caribbean has risen in the past two years. All the others are down double digits... far outstripping the S&P 500 Index, which is down 10% in that time frame.

At the time, movie-theater operator AMC had more than $5.4 billion in long-term debt and no clear way to pay it off. Its net income was only positive once in the past five years.

No wonder the stock dropped from more than $270 per share to roughly $8 per share in less than two years.

The same is true for used-car dealer Carvana. It loses money every single year... and by the end of 2021, it had more than $3 billion in debt. Shares plunged from $230 to about $40 per share today.

Now, most folks don't consider themselves credit experts...

But you don't need to know everything about the bond market to do a little analysis.

You can start with a quick look at the past few years of income compared to total debt burden. You'll get a better idea of whether or not the company stands a chance of paying off its debts.

And if you're ready to take your investing a step further, my team and I recently launched a brand-new credit advisory called Credit Cashflow Investor...

Each month, we'll dive into a new opportunity in a bond from a misunderstood company. We're looking for safe businesses with healthy credit setups... But for one reason or another, the market believes they're far riskier than they actually are.

(Here's a hint: It usually has to do with faulty as-reported accounting or other misleading metrics.)

If you're like most of our subscribers, bond investing is brand-new territory. That's OK. We explain everything you need to know about the credit market... and why we're about to see one of the best setups for bond investors since the Great Recession.

You can learn more – including how to get 50% off your Charter Membership – by clicking here.

No matter what, as we gear up for the next recession, keep in mind that credit health doesn't begin and end with the credit market. It touches every aspect of investing and the economy.

And that's one of the great secrets of bond investing. It doesn't just make you money on your bond investments... It can make and save you money in stocks as well.

Regards,

Rob Spivey
October 3, 2023