Post by bobfl on Nov 4, 2022 12:26:41 GMT
I realize this is a 101 basic post, probably not something 99% of the members here even care to read, because you know this. 
If you want to catch my mistakes or if you are new to income investing, read on...
Even after income investing for over 20 years, I was surprised recently about how much these cash rich companies borrow; it can be billions. Why borrow? I did the economics for every investment we made for companies I worked for. The minimum Return on Investment (ROI) we had to get before we made an investment in a plant, equipment, etc. was 20%. So even if we had the money to build a plant, if we could borrow it at 6% to make 20%, that is what we did.
So how do the companies borrow?
1. Banks
2. Issue common shares
3. Bonds
4. Preferreds (3 & 4 are used by the smart money people like banks.)
5. Private equity (Blackstone, KKR, etc.)
6. (Add some)
So where do they get the money? Mostly from us. Our cash thru direct investment, through funds, through pension plans, through insurance premiums, college endowments, deposits (see note at bottom), etc. It can come from other places like foreign governments, etc. (You can think of more.) For example, the NYC pension funds have so much money that they will pay financial advisors $350 million each year to manage (invest) their money.
Bottom line, if these companies were smart they would have exchanged as much old debt ((if they could call debt back) or issued new debt when the Fed Fund rate was zero .
So what is the impact of inflation.
When inflation hits, the Fed raises rates. The new cost to borrow goes up. Old debt is equally affected. Something that was issued at 4% for $25 giving you $1 per share, still gives a dollar, but the price has to drop so the return matches the prevailing cost of capital. Let's say that $1 has to now yield 6.25% to the buyer you are selling to, so the price has to drop to $16. But when the Fed drops rates the price goes up to match a lower % the big companies have to pay to borrow.
Why can higher rates be a problem to some companies? If they finance daily operations with a line of credit with a variable rate. If they have a low-rate debt expiring and have to refinance at a lot higher rate. Or they for example are building a new plant and have to finance now. But they can get short term money at a current high rate that they can refinance if the rate drops (think home mortgage).
This is a quick note on this topic from my view point. Any knowledgeable income investor can add much more to this topic. A professional could write a 400 page book on the topic.
(Note: A very large stock broker, [you probably use them] just got roughly a $150 million fine because with a routine robo adviser it advised the clients to put a small % in cash due to these uncertain times. They made so much off this extra cash that the gov said they must give it back [actually the gov got it from what I can determine]. They were fined because they should have advised the client that they could have placed the cash in other places where they could have made money, like MM. ) The fine did not really hurt them because they just reported $6.26 billion in net income.)
If you want to catch my mistakes or if you are new to income investing, read on...Even after income investing for over 20 years, I was surprised recently about how much these cash rich companies borrow; it can be billions. Why borrow? I did the economics for every investment we made for companies I worked for. The minimum Return on Investment (ROI) we had to get before we made an investment in a plant, equipment, etc. was 20%. So even if we had the money to build a plant, if we could borrow it at 6% to make 20%, that is what we did.
So how do the companies borrow?
1. Banks
2. Issue common shares
3. Bonds
4. Preferreds (3 & 4 are used by the smart money people like banks.)
5. Private equity (Blackstone, KKR, etc.)
6. (Add some)
So where do they get the money? Mostly from us. Our cash thru direct investment, through funds, through pension plans, through insurance premiums, college endowments, deposits (see note at bottom), etc. It can come from other places like foreign governments, etc. (You can think of more.) For example, the NYC pension funds have so much money that they will pay financial advisors $350 million each year to manage (invest) their money.
Bottom line, if these companies were smart they would have exchanged as much old debt ((if they could call debt back) or issued new debt when the Fed Fund rate was zero .
So what is the impact of inflation.
When inflation hits, the Fed raises rates. The new cost to borrow goes up. Old debt is equally affected. Something that was issued at 4% for $25 giving you $1 per share, still gives a dollar, but the price has to drop so the return matches the prevailing cost of capital. Let's say that $1 has to now yield 6.25% to the buyer you are selling to, so the price has to drop to $16. But when the Fed drops rates the price goes up to match a lower % the big companies have to pay to borrow.
Why can higher rates be a problem to some companies? If they finance daily operations with a line of credit with a variable rate. If they have a low-rate debt expiring and have to refinance at a lot higher rate. Or they for example are building a new plant and have to finance now. But they can get short term money at a current high rate that they can refinance if the rate drops (think home mortgage).
This is a quick note on this topic from my view point. Any knowledgeable income investor can add much more to this topic. A professional could write a 400 page book on the topic.
(Note: A very large stock broker, [you probably use them] just got roughly a $150 million fine because with a routine robo adviser it advised the clients to put a small % in cash due to these uncertain times. They made so much off this extra cash that the gov said they must give it back [actually the gov got it from what I can determine]. They were fined because they should have advised the client that they could have placed the cash in other places where they could have made money, like MM. ) The fine did not really hurt them because they just reported $6.26 billion in net income.)
