Owning shares in a bond mutual fund in one of the more perilous things an investor can do. A mutual fund that owns bonds faces risks that you don’t face if you own the individual bonds. Specifically, when market fluctuations reduce the value of the assets it holds, shareholders tend to take out their money, forcing the fund to sell assets at a loss. This locks in the losses for the fund, reducing the value of the shares that remain.
Something similar is happening in ordinary business corporations these days. Routine borrowing is more difficult than ever for businesses these days, whether they borrow by issuing bonds or taking out loans. The risk that companies won’t be able to refinance their debts hurts the stock price of the company, if it’s publicly traded, making it harder for the company to raise money by issuing more stock. If it does issue stock to raise money, that brings in only a small amount of money, while reducing the value of the existing shares. It’s almost like what happens in bond funds.
It’s just not the best time for a company to be in debt. That’s why so many companies are cutting back on the dividend payments they make to their shareholders. The companies are better off, and the stock price will be higher, if the companies use the money to reduce the amount of debt they owe.
General Electric (GE) is one of several companies to cut dividends over the weekend. In GE’s case, the dividend had been the same, 31¢ per share per quarter, for ages. In the meantime, the company had piled up more than $500 billion in debt, and the massive debt load was weighing on the stock. Cutting the dividend to 10¢ a share gives GE an additional $9 billion per quarter to make payments on its debts. It might not sound like a lot, but since debt does not all mature at the same time, it could go a long way toward paying the debt as it matures, so that not much debt has to be rolled over. Depending on GE’s future earnings, the additional money could allow it to pay off its debts five or ten years faster. Or, if it gets squeezed, it could make the difference between making its debt payments and not making them.
Massive amounts of debt didn’t seem as risky five or ten years ago, so lots of corporations, even ones that pay dividends, are loaded with debt. The current financial climate, when refinancing debt is especially hard, is prompting many of these companies to put more emphasis on paying down their debts and putting themselves in a stronger financial position.
