Understand which is more risky: investing in companies through shares or debt? – 10/11/2023 – From Grain to Grain

Whenever I talk about investing in private credit fixed income securities, I soon receive criticism such as: you forgot to remember the companies that went bankrupt or in process such as: Americanas, Rodovias do Tietê, Light and others. So, is investing in credit securities more risky than investing in shares?

Wrongly, it is common to think that credit risk is greater than that of stock fluctuations.

I tend to associate credit risk with a plane crash. Plane crashes occur less often than one might think, but as when they happen the impact is relevant and affects many people at the same time, it is more traumatic. Therefore, we believe it occurs more frequently and is worse.

Also, the proportion of companies with shares traded on the stock exchange is small in relation to the total number of companies and only the most mature ones are listed. Unlike companies with credit bonds.

Therefore, we tend to compare incorrectly, that is, all companies with credit with the few companies that have shares on the stock exchange.

However, the correct thing to compare is within the same universe. In this case, we must compare the results of credit and shares only in companies with shares traded on the stock exchange.

When we compare correctly, the reasoning for understanding who has less risk is simple.

Just answer the following question: if a company has shares on the stock exchange and debts, such as debentures, and it goes bankrupt, who is the investor who ultimately receives any remaining resources, the shareholder or the creditor?

In this case, the shareholder is always the last to receive. Shareholders only receive what is left after taxes, employee rights and creditors have been paid.

Often when a company fails, creditors take the place of shareholders who lose everything. This happened with OGX, with the concessionaire Rodovias do Tietê and is happening in part with Americanas at the moment.

Therefore, investing in shares is riskier than debt.

In addition to being more risky, the return from investing in shares in Brazil was worse than that from investing in fixed income. This happened and could still happen, as we have a very high interest rate.

We know that stocks tend to follow earnings growth.

So, ask any analyst how much they expect the profits of any company on the Stock Exchange to rise in the long term. In a few cases this analyst will estimate that profits will grow well above inflation in the long term.

The average profit of an index may rise more than inflation in the long term, as new companies with high potential emerge that push the average upwards, but this growth will not be greater than the sum of inflation and economic growth. The sum of these two results in IPCA+2.5% per year.

However, in Brazil, there is a full supply of IR-exempt fixed income securities from companies traded on the stock exchange with rates of IPCA+6.5% per year. For many, this return is possibly greater than the companies’ own profit growth.

Thus, the balance of return per risk in private credit investment in Brazil is exceptionally interesting. You have lower risk than in shares and in many situations a better return.

Michael Viriato is an investment advisor and founding partner of Investor’s House.

Speak directly to me via email.

Follow and like De Grão em Grão on social media. Follow investment lessons on Instagram.

LINK PRESENT: Did you like this text? Subscribers can access five free accesses from any link per day. Just click the blue F below.