The Bond Bubble

Johnson & Johnson (JNJ) smartly takes advantage of the bond bubble. The rule is simple: When rates and stock prices are low, it’s better to raise money through debt. When stock prices and interest rates are high, issue stock.

Johnson & Johnson sold $1.1 billion of debt at the lowest interest rates on record for 10-year and 30-year securities amid surging investor demand for corporate debt.
The drugmaker, in the first offering by a nonfinancial AAA rated company in 15 months, sold $550 million of 2.95 percent, 10-year notes and the same amount of 4.5 percent, 30-year bonds, according to data compiled by Bloomberg. That’s the lowest coupons for those maturities on record, according to Citigroup Inc. data going back to 1981.
“Even though some faith in the rating agencies has been blown, the triple-A is still sacred,” said Guy LeBas, chief fixed-income strategist and economist at Janney Montgomery Scott LLC in Philadelphia.

JNJ’s dividend yields 3.6%. This means that you could issue as much 10-year debt as you can and use it to buy the shares. The stock can rise another 22% from here and you’re still getting a higher yield than your interest payments (.036/.0295=1.22). And that doesn’t count the likely dividend increases.
I guess the obituaries for the Equity Risk Premium were a bit premature.

Posted by on August 12th, 2010 at 5:16 pm


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