Introduction to Company Bond Ratings for Investors
A company’s bond rating is very important to income stock investors. The bond rating offers insight into the company’s financial strength. Bonds get rated for quality for the same reasons that consumer agencies rate products like cars or toasters.
Standard & Poor’s (S&P) is the major independent rating agency that looks into bond issuers. S&P looks at the bond issuer and asks, Does this bond issuer have the financial strength to pay back the bond and the interest as stipulated in the bond indenture?
To understand why this rating is important, consider the following:
A good bond rating means that the company is strong enough to pay its obligations. These obligations include expenses, payments on debts, and declared dividends. If a bond rating agency gives the company a high rating (or if it raises the rating), that’s a great sign for anyone holding the company’s debt or receiving dividends.
If a bond rating agency lowers the rating, that means the company’s financial strength is deteriorating — a red flag for anyone who owns the company’s bonds or stock. A lower bond rating today may mean trouble for the dividend later on.
A poor bond rating means that the company is having difficulty paying its obligations. If the company can’t pay all its obligations, it has to choose which ones to pay. More times than not, a financially troubled company chooses to cut dividends or (in a worst-case scenario) not pay dividends at all.
The highest rating issued by S&P is AAA. The grades AAA, AA, and A are considered investment grade, or of high quality. Bs and Cs indicate a poor grade, and anything lower than that is considered very risky (the bonds are referred to as junk bonds).