Stock Price and Bond Price

📉 Lower stock price for a company means lower profits in future than previously assumed.

🚩 Sharply falling bond price signals the company has a higher bankruptcy risk than previously assumed.

⛈️ Since this is the first real recession for many of us, let’s dive into part of finance that helps identify risks in public companies.

🕵️‍♀️ Let’s take two similar, yet different, companies as an example:

📈 Square/Block (SQ) and Coinbase (COIN) saw dramatic share price increases during 2020 and 2021 as both companies benefited tremendously from Bitcoin/Cypto enthusiasm. Stock prices for both companies rose sharply based on the promise that they will make even more profits in the future. 🤑

🏦 Both companies also issued debt (called corporate bonds) to finance their operations. Banks, pension funds, and mutual funds buy these bonds to earn interest. These bonds are bought and sold in the secondary market, so their value changes over time based on economic conditions, prevailing interest rates, company’s financial prospects etc.

↘️ In 2022, the narrative for Crypto changed dramatically. Future profit expectations came down drastically. Since stock price is the sum of expected future profits, both companies’ stock prices dropped around 75%-85% this year, before recovering a bit.

🤯 But, when you look at the bond prices for both, they tell a vastly different story.

🔲 SQ’s bond prices have declined a little bit because of rising interest rates, but the decline is similar to that in Adobe, Apple, Disney etc. This means that the bond holders believe that there's a really small chance of SQ going bankrupt before the bonds mature. $100 SQ bond issued in 2021 is currently selling at $88.

💣 COIN’s bond prices, on the other hand, have crashed around 40% this year. Bond holders believe there's a decent chance of COIN not being able to pay its debt back or the interest. Last week, $100 COIN debt/bond was selling for around $57. Past bond price data suggests that the probability of COIN's bankruptcy is around 38%*.

🏁 Bond prices are merely signaling that Square/Block has less downside risk from crypto meltdown, quite possibly because Square also has a strong payments business catering to SMBs, as well as other products that make money not related to crypto. Whereas Coinbase makes most of its money in crypto, which is on shaky grounds at this time.

🎯 If you are thinking of investing in a company's stock, also look at its bond prices to get a sense of potential downside risk.

💰 Stock price reflects potential upside in the future.

🔑 Bond price reflects potential downside in the future.

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