Credit Rating vs. Equity Research: What’s the Difference?

Credit Rating vs. Equity Research: An Overview

As far as investment analysis is concerned, credit rating and equity research refer to different valuations used for different types of investments. Credit ratings are used for debt-based instruments; just like individual credit ratings represent the likelihood of consumer repayment, investment credit ratings represent the likelihood the issuing body will repay investors.

Equity research is concerned with equity securities, such as company shares. Equity research is used to guess the possibility of asset appreciation, dividend payouts, and other equity valuations.

Neither credit ratings nor equity research is meant to act as recommendations to purchase any specific investment; rather, they are only inputs used by investors to evaluate and compare investments. Your investing strategy should be based on several other factors, including your own time horizon and risk tolerance.

Key Takeaways

• Credit ratings and equity research provide investors with company insight and help with making investment decisions.
• Credit ratings focus on the likelihood of a borrower defaulting on their debt, and center on debt instruments, such as bonds.
• Equity research digs deep into a company’s financials in order to determine the growth potential of shares.
• Credit ratings are standardized and issued by established credit rating agencies, such as S&P and Moody’s.
• Equity research is conducted by many different bodies, such as brokerages, independent research firms, and investment banks.

Credit Rating

There are three major credit rating agencies for investment products: Moody’s, Standard & Poor, or S&P, and Fitch. These agencies are responsible for more than 90% of the listed credit ratings for global debt instruments.

Credit ratings are assigned to short-term debt, long-term debt, securities, business loans, and preferred stock. Due to the nature of the insurance business model, credit ratings are also handed out for insurance companies to evaluate their ability to meet their obligations for insurance claims.

Credit ratings in the investment world are usually represented by letters, not numbers, as with consumer credit scores. The exact letters used vary between types of investments and the issuing credit rating agency.

For example, S&P’s ratings for long-term debts range from “AAA” to “D,” moving from safest to most speculative. Ratings are applied to specific debt obligations or debt issuers as a whole and can be downgraded or upgraded if circumstances or information changes.

Important

Credit ratings fall into two buckets: investment grade and non-investment grade. The former indicates debt instruments that have a low risk of default and, therefore, offer lower yields. The latter indicates riskier investments that come with higher yields.

Equity Research

Not all equity research is easily comparable. Research offered by major brokerage firms, or “Wall Street research,” is generally very focused on large and liquid equity investments. There are many reasons for this, but perhaps the most significant factor is that large-cap stock analysis tends to be more profitable.

After all, large investors pay the most for research. Smaller, independent research firms provide much of the research on other equity investments, sometimes on a fee-based basis. This information can be harder to obtain, although the proliferation of Internet-based analyses has helped make the analysis more widely available.

Equity research is focused on the risk-return potential of an investment. In theory, equities are riskier than debt instruments. Research also tends to be specialized by asset categories, such as “mining,” “healthcare,” “retail,” etc.

Equity research can be both highly quantitative and/or more nuanced, to provide insight into both company-specific variables and sector- or market-wide variables. Both credit ratings and equity research are useful and important tools made available for investors, but neither should be taken as the end-all-be-all for making investment choices.

Key Differences

Both credit ratings and equity research provide company insight for investors but differ in their approach. Credit ratings are issued by companies that have the legal authority to analyze and provide an analysis and recommendation to the public. They carry a lot of importance and greatly affect investor decisions. As such, they are highly regulated.

Equity research is often carried out by many different analysts and firms, with different levels of independence. Because of this, bias can be prevalent in equity research, especially by firms that may benefit from promoting a particular stock.

Credit agencies focus primarily on an entity’s ability to pay back interest and principal, thus, assessing the creditworthiness of the entity in relation to debt instruments. Credit agencies use standardized methodologies.

Equity research firms go deeper into a company’s financials, looking at its overall performance, growth prospects, operational efficiency, and competitiveness in the market. It looks not only at quantitative factors, such as financial ratios but also qualitative factors, like management’s experience.

So while both credit ratings and equity research are useful to investors, what they provide has different value. Credit ratings focus on the likelihood of a borrower defaulting on their debt while equity research is more forward-looking in order to determine a stock’s growth potential.

What Is the Best Credit Rating for Bonds?

Bond credit ratings are provided by three main agencies: S&P, Moody’s, and Fitch. Each has its own rating scale. The best credit rating for a bond as provided by S&P and Fitch is AAA. For Moody’s, it is Aaa. These ratings indicate the highest quality bonds, those that have the lowest chance of defaulting.

What Is the Difference Between Equity Research and Credit Research?

Equity research focuses on the growth potential of a company’s shares, assessing different financial information to understand where a stock’s price may go. Credit research focuses on downside potential; the likelihood of a company defaulting on its debt obligations.

Do Private Companies Have Credit Ratings?

Yes, private companies can have credit ratings. The main rating agencies (S&P, Moody’s, and Fitch) can evaluate creditworthiness and issue ratings. Private companies, however, are not required to release as much financial information as public companies, so transparency is limited, which in turn limits the effectiveness of the credit rating.

The Bottom Line

While both credit ratings and equity research provide important insight for investors, their focus is different. Credit ratings will help investors looking at debt instruments, such as bonds, to determine the riskiness of a counterparty and its likelihood of default.

Equity research will help in understanding the overall financial profile of a company and its potential as a good investment for stock value appreciation.