Understanding the riskiness of corporate assets (equities and bonds) is critical

 

Too often investors think about the risk of equities or bonds in isolation. For equities, investors will think about total return and the pay-out through dividends. For bonds, the focus is on coupon payments and the risk to principal. Yet, it is important to think about the risk of combination of equity and bonds as total corporate assets, the pay-out to investors from all sources, dividends,coupon payments, and net repurchases. A recent study provides a new perspective on this issue, see "How Risky Are US Corporate Assets?" .

This study values US corporate assets and their payouts to investors which includes dividends, coupons, and bond principal. The authors find that payouts, unlike equity dividends, are highly volatile, turn negative when corporations raise capital, and are acyclical. However, corporate assets are sensitive to economic growth.  What is notable is the impact net repurchases which are often not cyclical alters the total payout to growth and the economic business cycle.

Investors, when thinking about risk and return should take a more holistic view when analyzing firms which includes all corporate assets that represent enterprise value.  A portfolio of both equities and corporate bonds should be viewed through a lens of total corporate risk.  Cash flow comes through dividends, coupon payments, and net repurchases, so investors must think about all sources of cash. If you hold both, you should think about total corporate asset risk versus the business cycle.

From an investor's perspective, this reinforces the idea that that capital structure matters and investors should focus on both equity and debt markets when thinking about market risks.