Aaa Stocks Rating
Aaa Stocks Rating
Four Essential Elements to Your Rate of Return
The rate of return used to calculate the value of an investment is an essential element to the investment. Understanding what a rate of return is and what it isn’t will help you in your investment decisions. Here are four elements that you should know about your rate of return.
First, a rate of return also known as the cost of capital is an element of the investment not the investor. This makes a lot of sense. Let’s say you want to buy a corporate bond as an investment. The bond will have a rating from the highest grade “AAA” to the lowest grade “D”. Depending on the grade, the return will be high or low. Investors with high grade bonds receive a lower return than investors with low grade bonds because of the difference in risk.
Who grades bonds? Is it the investor? How about a company issuing a corporate bond? If you answered neither one, you’re right. Bonds are graded by independent rating services like Fitch, Moody’s, and Standard & Poor’s. Their ratings take into consideration the bond issuer’s ability to pay the bond’s principal and interest in a timely fashion.
Second, the rate is an expected rate of return not a historic rate. A person buys an investment based on its expected future performance not what it has already done in the past. Sometimes history is a good indicator of future expected performance, but that’s not always the case. If you believe history is always a good indicator of expected future performance, could I interest you in buying some Washington Mutual stock for the price it was trading for before the housing market meltdown?
Third, the rate is based on the investment’s market value not its book value. Book value is an accounting amount carried on the balance sheet. It’s important to know the IRS allows owners to choose different types of depreciation methods from straight-line to accelerated depreciation. The estimated salvage value along with the election of Section 179 bonus depreciation can have an impact on the asset’s book value. This value can be materially different than the asset’s current market value.
Fourth, there is a difference between a discount rate and a capitalization rate also known as a cap rate. To be accurate, a discount rate is used to convert future amounts into present value. A discount rate is a rate of return, and it includes a long-term sustainable growth rate.
I know this may sound like heresy, but a capitalization rate is not a rate of return. A cap rate is a divisor used to convert income into value. The difference between a discount rate and a cap rate is that the cap rate doesn’t include a long-term sustainable growth rate. If it did, it would be a discount rate.
When you buy or sell any kind of investment, remember the investment return is not selected by the buyer or the seller. It is not based on book value or a historic rate. The rate comes from the marketplace for similar investments. These rates change with changes in the economy, industry, and risk specific to the investment. Similar to having a corporate bond graded by Fitch, Moody’s or Standard & Poor’s, wise investors have an independent, competent, person trained in valuations to perform an appraisal of the investment under consideration.
Whether the investment is stock in a privately held company, a piece of real estate, or any other kind of asset, it’s in your best interest to know its fair market value and the expected rate of return. If you don’t know, you could be short changed.
UNITED STATES WILL LOOSE AAA CREDIT RATING : STOCK MARKET FREEFALL 2011-2012
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