Security Analysis by Benjamin Graham and David Dodd was first published in 1934. It is a fundamental book for serious students of value investing.
Continuing on the specific standards for fixed value investments (for income purposes), Mr. Graham and Mr. Dodd discuss Bond terms, Dividend requirements, and Interest coverage criteria. The last one is the prime criteria.
The authors explain why favoring secured bonds over unsecured ones is not correct, and considering income bonds on par with unsecured ones is not the right attitude. Moreover, while selecting a shorter-term maturity bond the safety standards shouldn't be lowered.
The most important criterion for selecting bonds is earning coverage. The writers discuss the calculation methods, the minimum requirements, and the time period for this test. They advise against applying the coverage test to interest due for a particular bond into consideration. Rather, the coverage test should be applied to interest payments of all the outstanding bonds. Plus, the minimum coverage should be based on the nature of the industry. Lastly, it is important to take the average of the past year's earnings record to remove the impact of good and bad years. In addition, paying attention to other factors as well such as earning trend, minimum amount, and current value is helpful.
When deciding among bonds coupon rates play a role. A higher coupon rate and companies' ability to fulfill are related in an opposite way. For a strong company, this dynamic results in making it an even better credit given its ability to borrow at lower rates. Furthermore, a rise in the general interest rate can increase interest liability for a shorter maturity, and more adversely affect the market prices of long-term bonds.
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