There’s nothing wrong with relying on rating agencies to choose the best bonds. These firms can make or break an entity’s success in both the primary and secondary bond market. However, investors should know when to trust bond rating agencies.

In today’s market, we see numerous rating agencies out there. But the three major ones are Moody’s Fitch, and Standard & Poor’s. These agencies assign credit ratings for issuers, which includes companies, state and local governments, or nonprofit organizations. Each agency uses their own models in assessing the creditworthiness of an entity.

The credit rating signifies the likelihood of a firm to pay interests over the bond’s life. In the case of corporations, it also indicates the potential marketability of bonds and the company’s capacity to return the principal once the bond reaches its maturity.

Credit analysts have their own approach when evaluating a company’s creditworthiness. But when it comes to comparing bonds, it is a good idea to determine whether the bonds are investment grade or non-investment grade. It does not follow that investment grades are safe and non-investment grades are not. Investors still need to look into the sub-sectors within the overall ratings. Remember, these are static ratings since these are susceptible to constant changes. Therefore, investors, especially the new ones, these are not enough to come up with long-term assumptions.

Investors highly regard these ratings, so do companies. It affects a firm by changing the cost of borrowing the money it seeks to leverage a balance sheet. Therefore, a higher cost of capital due to greater interest cost begets lower profitability. Ratings also influence the way issuers use the capital even though interest paid is frequently taxed differently than dividend payments. Borrowers expect a higher return on the borrowed money than the capital.

Aside from that, credit ratings over time impact bonds’ marketability in the secondary market, corporations’ capability to issue stock, analysts’ methodology of reading the level of debt on a balance sheet, and a major aspect of viewing a firm.

Definitely, it is a good start to use the data provided by credit rating agencies. But investors should their homework, too. Do your own research.