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The unique quality of convertible securities is that they provide the benefits of a “straight, non-convertible” bond—fixed income and investment value—as well as a call option (the conversion feature) on the common stock underlying the convertible. The bond-like portion has a certain value (referred to as its investment value) that is based on many factors including the financial strength of the issuing company, the size of the coupon, the time to call/put, and time to maturity. That value generally supports the convertible’s price, if the underlying stock should experience any setbacks. The call option gives holders the ability to exchange the convertible for shares of the common stock, particularly if the price of the stock becomes greater than the conversion price.

The conversion feature, meanwhile, means that as long as the underlying stock price is advancing, the convertible value will also increase, albeit to a lesser degree. However, if the common stock price becomes equal to the conversion price—the price of the stock at which the premium over conversion value disappears—the rise in the convertible’s price will be in step with that of the stock. Therefore, convertibles whose underlying common stocks show the potential for above-average growth position the bondholders for above-average capital gains, as well as above-average total returns.

Each week, The Value Line Investment Survey identifies 100 companies with the highest growth rate and strong 3- to 5-year appreciation potential. To be included, a company’s annual growth of sales, cash flow, earnings, dividends, and book value must together have averaged 10% or more over the past 10 years, and be expected to average at least 10% in the coming 3 to 5 years. Convertibles issued by these companies tend to have returns nearly equal that of the stock, and often at a lower risk level. Many of the high-growth companies included on the Value Line list have convertibles. Below is a partial list:

 

Maturity

Recent

Conv

Conv

 

Com

Com

Convertible Securities

Date

Price*

Curr Yld(%)

YTM(%)

Industry

Price*

Yield

FTI Consulting 3.75s2012       

7/15/2012

126.63

3.0

 NMF

Ind Sv

$36.89

 NIL

Rovi Corp. 2.625s2040 (144A)   

2/15/2040

137.88

1.9

1.1

Entmnt

$58.25

 NIL

Steel Dynamics 5.125s2014      

6/15/2014

127.13

4.0

 NMF

StlGen

$18.11

1.7

 

 

 

 

 

 

 

 

* Prices as of 12/28/2010

 

 

 

 

 

 

 

Selected Convertible Highlights:

Rovi Corporation (formerly Macrovision Solutions) (ROVI) provides a wide-array of services that enable businesses to protect, enhance, and distribute their digital goods to consumers across a variety of mediums. Its offerings include digital rights management products and technologies, content protection technologies and services, and embedded licensing technologies.

With the common stock already priced above its 3-to 5-year Target Price Range, and way above the conversion price of $47.36, Rovi’s 2.625% convertibles are trading deep in the money. However, the notes are not callable until February 20, 2015, which gives ample time for further potential gain if the stock continues to soar.

 

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.