Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Rising Star

What it is:

Rising star companies have a low credit rating (often "junk"), but only because they are new to the bond market or still establishing a track record. 

How it works (Example):

A rising star is a relatively new company that doesn't yet have the track record and/or the size to earn an investment-grade rating from a credit rating agency like Standard & Poor's or Moody's

For example, let's say Company XYZ is a small video gaming company. Company XYZ is profitable, but it needs $10 million right now so it can hire new programmers to expand its line of video games. XYZ decides to borrow the $10 million in the bond market.

Because it has no history of borrowing or paying back debt, the credit ratings agencies have no choice but to rate XYZ's bonds as "BB" or lower.

Why it Matters:

Junk bonds are typically divided into two categories: Rising stars and fallen angels.

A fallen angel is a bond that once had a high rating but has since been downgraded to junk status (for example, General Motors when it declared bankruptcy). A rising star is a bond that has potential to be upgraded once the company establishes an outstanding track record of paying back its debt.

All things being equal, a investor would rather invest in a rising star's junk bond instead of a fallen angel's junk bond. A rising star has promising underlying financial performance and just needs some time to establish its credit history. A fallen angel once had an investment-grade credit rating, but has experienced some kind of financial degradation requiring a downgrade to "junk." In short, a rising star is on the way up, and a fallen angel is on the way down.