Interest Or Yield - What Is Better For You?

Shmulik is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Strange things happen in a zero percent interest rate environment. When money is so cheap and alternative investments yield so little, investors are forced to settle for much less than they used to in the past. But unlike investors, corporations are infinite entities. They are always able to take advantage of current opportunities, with the expectation of being rewarded only dozens of years down the road.

A wave of refinancing

The current opportunity for corporations is the option to refinance their debt at ridiculously low rates. By doing that, they are able to maintain low cost for debt servicing in the future. Although this makes companies load their balance sheets with debt, making it more fragile, the opportunity is simply too great to resist. Any company that has access to the debt market is doing so right now.

The latest candidate to refinance is Intel (NASDAQ: INTC). The giant semiconductor manufacturer recently announced the pricing of senior unsecured notes aggregating $6 billion. These bonds have been issued in four tranches of different amounts, with varying coupon rates and maturities. The first tranch in the amount of $3 billion carries a coupon rate of 1.35% and matures in 2017.

Intel is not the only company selling debt on the cheap. Back in July, International Business Machines (NYSE: IBM) sold $1 billion 10-year notes with a coupon of 1.875%. This debt sale set a record as the lowest interest rate for bonds of that maturity sold in the US, according to Dealogic, the data tracker.

Microsoft (NASDAQ: MSFT) also followed suit. The company that was most famous for maintaining zero debt on its balance sheet finally began leveraging itself. As of this writing, Mr. Softy has $12 billion of fresh debt. Although this is only a small portion of its $66 billion in cash, it is still worth noting.

Not everyone can raise money at such low rates, of course. This privilege is mainly reserved to companies of significant magnitude with ample cash flow and a fortress-like balance sheet such as IBM, Intel and Microsoft.

Does this make any sense?

When companies sell excessive amount of bonds, it is imperative to pay attention to where all this money is going. In Intel's case, for example, the company made this very clear. It intends to buy back its own shares and retire them. Currently, Intel pays a $0.90 dividend, and with the stock trading below $20 per share, the yield is over 4.5%

Look at it this way - the company is raising money for 1.35% in order to retire shares that 'cost' the company 4.5% a year (rate of current dividend yield). This makes perfect sense both for the company and for its shareholders, who will witness their EPS gradually grow as the number of  shares decrease.  

A lucrative opportunity for you

An investor who steps up and buys Intel's bonds will be rewarded with a measly return of 1.35%. This means that he or she is almost sure to lose to inflation (at a rate of 2%-3% a year) over the long haul. In contrast to this bond buyer, consider shareholders. A new shareholder in the company is now looking at a mouth-watering dividend yield of 4.5%, which makes Intel one of the highest-yielding stocks in the Dow Jones.

If you count in the share buyback program (expected to decrease share count by 5%), the 7% increase in dividend payouts (a conservative estimate), and the current earnings multiple of 8, a shareholder is looking at a total annual earnings yield of approximately 18% per share. Compare this to the 1.35% on the company's bonds.

The Foolish conclusion

Companies that can raise debt on the cheap today are obligated to do so for the ultimate benefit of their own shareholders. Intel is currently doing precisely what it should: It is raising money on the cheap and buying its own undervalued shares. By doing just that, it is effectively sending a signal to the market that it is both financially stable enough to be able to raise money at such rates, and that it intends to put the interest of its shareholders first.

I would buy Intel shares without a blink.


Shmulik Karpf owns shares of Intel Corporation (INTC) and Microsoft Corporation (MSFT).The Motley Fool owns shares of International Business Machines, Intel, and Microsoft. Motley Fool newsletter services recommend International Business Machines, Intel, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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