Corporate Credit Ratings & Your Investments – Why You Should Care
Do you want to ensure you are only investing in quality companies or funds? (Hopefully you said yes.) How do you figure out what a quality company is? There are many tools to help identify the best companies to manage your investment dollars. One way to help assess the quality of a company is to look at what credit ratings agencies, such as Moody’s or Standard & Poor’s, think of it.
These credit rating agencies measure a company’s ability to repay its debts. Companies often take on debt to help them grow and invest in new areas. These debts can be loans or bonds issued to investors. A company’s ability to repay its debt helps show sustainability. If a company is struggling to pay debts, it has a higher chance of failure. These failures usually take your investment with them.
Therefore, you may to look for companies with investment grade credit ratings to reduce your likelihood of losing money on an investment.
What Ratings System Do Ratings Agencies Use?
Credit ratings agencies will review a company and give it a rating. AAA is the highest credit rating any company can get, meaning it is highly unlikely that company will default on its debt payments. You will also see AA and A ratings, which are each a little less stellar than the previous rating, but still good. To give you an example, most of Canada’s large banks are rated either A or AA, meaning they have a low likelihood of default. AAA ratings are most often seen on bonds issued by stable federal governments, such as Canada. (Since a government can raise taxes to generate the revenue needed to pay its bills.)
The lowest possible rating depends on the ratings agency, but it’s usually a C or D. If you’ve ever heard the term junk bonds, these are bonds issued by companies with extremely low credit ratings. Junk bonds usually offer a higher rate of return to attract investors, but they are also the most likely to default on their payments. In other words, the higher possible reward is offset by much higher risk. Sure, their bond might pay double the amount of an A rated company, but there is no guarantee you will ever see your money.
Are Credit Ratings the Only Thing You Need to Investigate Before Investing?
Heck no! There are many facets you want to investigate before handing over your hard-earned cash. Does the company have stable cash flows and earnings? If they have dividends, do they pay them reliably? Does the investment align with your financial goals? There are many things to consider when making an investment. Credit ratings are just one small piece of the puzzle.
Your best bet is to work with a financial planner or someone with a solid financial background who understands the nuance involved in investing. AAA credit ratings are not a guarantee of investment success, but they certainly add an extra layer of peace of mind.