Both stocks and bonds are part of a corporation’s balance sheet. A bond is a loan to a company, and a stock is an equity in the company. So, if you buy stock, you own part of that company. When you buy a bond, you become a creditor of that company.
Stocks and bonds are affected by inflation and interest rates. Stock prices go up when interest rates go down, and conversely they go down when interest rates go up. In trader terms: Rising interest rates are usually bearish for stocks while falling interest rates are bullish for stocks. And a rising bond market is also usually bullish for stocks, while a falling bond market is bearish for stocks. Bonds are often a leading indicator of where the stock market is going; therefore, when analyzing the stock market, it is important to also do a technical analysis of the bond market.
When buying a stock, you should always look first at the price-per earnings ratio (P/E. ratio). The lower the number, the better the price you are getting when you buy into a company. When buying a bond, you will want to get your bond rate by dividing one into the P.E ratio of a stock. So, a P.E. ratio of 20 is a bond rate of 5%. (20/1).
If the P.E, ratio is 45, the bond rate is 2.2% (45/1). Bondholders get a good rate when stocks are overpriced. The P.E. ratio goes hand in hand with interest rates and thus with bond rates. You should always look at bond rates before buying or selling a stock and remember that high P.E. ratios will adjust eventually. In other words they will fall, and your bond rate will increase. Stock earnings as a whole are typically higher when the company is undervalued (has a low P.E. ratio).
Bonds increase in value if interest rates decline, which means you can sell the bond at a higher price. (Bear in mind, the profit you make is called “Capital Gains”, two words that will interest the Internal Revenue Service). You can also make money from the interest payment during the bond term which is similar to dividend payments from a stock holding.
Publicly-traded corporations issue bonds and stocks to raise money to expand their businesses, which is where you, the investor, comes in. The general idea of investing is to reduce your risk, especially in these turbulent times. Both bonds and stocks can be risk-free, or they can be high-flyers that crash and burn. So, always do your homework before investing your money.