Convertible Screen
High-Yielding Convertible Bonds - August 25, 2010
Uncertainty about the direction of the equity markets and economic conditions has investors scurrying to find safe havens for their investment dollars. While bonds provide such safety, yields are currently very low and there is little potential for capital appreciation over the long term. And the low interest-rate environment makes the return on holding cash virtually non-existent. Convertible bonds, however, offer an interesting middle ground between the safety of bonds and the upside potential, and risk, of stocks.
Convertible Screen
Surrogate Convertibles with a Current Yield Advantage over Underlying Common Stocks
Because of the high volatility being experienced in the equity markets, convertibles are trading with high premiums over conversion value as their underlying common stock prices decline. In fact, as of August 13, 2010, the average convertible traded with a 52% premium over conversion value and a 17% premium over investment value. Such conversion premiums limit the convertibles’ participation in the stock price movements. But, despite rather lackluster economic conditions, we can still find a few companies whose stocks are performing well and the convertibles issued by these companies are also doing well.
Convertible Highlight
Gilead Convertible Debt Sale
The convertible new issues market got a needed “shot in the arm” from Gilead Sciences’ (GILD) $2.2 billion of convertible debt, the biggest sale since Ford Motor Company (F) sold $2.5 billion of 4.25% convertible debt due 2016 in November 2009. On July 27, 2010, Gilead issued $1.1 billion aggregate principal amount of 1.00% convertible senior notes due 2014 and $1.1 billion aggregate principal amount of 1.625% convertible senior notes due 2016 to qualified institutional buyers (QIBs) under SEC Rule 144A of the Securities Act of 1933.
Convertible Screen
Convertibles Screen: Top Convertibles with Poorly Rated Underlying Common Stocks
We screened our database for convertibles ranked 1 or 2, whose underlying common stocks were ranked 4 or 5 by Value Line, and found 42. The average current yield of the group is 6.1% compared to 0.9% from all the common stocks. Even if we measured only the common stocks paying dividends, the average convertible in this group would generate a yield of 6.1% versus 3.6% from the underlying stocks.
Commentary
Especially Recommended Convertibles Still in Positive Territory
Expectations for an improved domestic economy in the second quarter only materialized partially. Indeed, things seemed to be slowing again as the period ended after the initial burst. Our Especially Recommended Convertibles Index fell 1.3% in the second quarter, but it too remained positive for the year, up 2.7%. Our performance results underscore the defensive nature of our portfolio. While past results are no assurance of future performance, Value Line's Convertible Ranking System has proven effective over the years.
Convertible Highlight
Microsoft's New Convertible Debt Issue
Microsoft’s (MSFT) sale of convertible notes could add some energy to the otherwise lackluster convertibles market. Around June 9, 2010, the company raised $1.25 billion of interest-free financing from its first sale of convertible notes in years.
Commentary
Cadence Design Systems New Convertible Senior Notes due 2015
Cadence Design Systems (CDNS) recently priced an offering of $300 million principal amount of cash convertible senior notes due 2015.
Convertibles as an Asset Class
Investors, searching for safer havens, are pulling out of stocks and investing in bonds and government securities. Indeed, the Dow Jones Bond Average gained 0.8% in January, while our All Convertibles Total Return Index grew 1.8%. Even the government is considering the option of buying “convertible securities from financial institutions,” with bailout money (according to an article in the January 21st Wall Street Journal). Because of their hybrid nature, convertibles could be the ideal investment for investors “hooked” on stocks, as we go through this recession. A convertible has an investment value (a bond value); it pays income, which is generally higher than that of the stock; and the warrant portion gives holders a call option on the underlying stock when equity markets perk up again. And, they are more stable than stocks.
A Convertibles Primer
Convertibles are a niche investment that are, unfortunately, on the outskirts of most investors’ radar screens. A quick primer, however, might help change that.
What is a Convertible Bond?
Convertible bonds represent a debt of the issuing corporation and are commonly designated by the rate of interest paid and the year of maturity. The price at which a convertible is traded is quoted as a percentage of $1,000 (or par).
Why Convertibles Often Carry Less Risk than Common Stocks
Risk typically increases with potential return. There are, however, some investments that historically have provided larger than expected returns in proportion to the risk of the securities involved. Convertibles fall into this category.