Value Line and convertibles

Dear Mr. Berko:

Could you explain convertible bonds to me? I know some of them pay very high yields, and I would like to invest in them, but my broker knows nothing about this kind of investing. I called Value Line, which publishes information on convertible bonds (I subscribe to its stock survey), but the people there wouldn't send me a sample (even an old sample) to preview. This is really dumb because I'm not going to spend $600 a year for a monthly service without seeing it first. How can I find convertible names worthy of investing in?

PW, Fort Walton Beach, Fla.

Dear PW:

Most stockbrokers think a "convertible bond" describes an emotional attachment to an automobile in which its roof, upon the driver's demand, retracts into a well so the car becomes a topless transportation vehicle. About 17 percent of stockbrokers (only those born prior to March 1962) know a convertible is a corporate bond (sometimes it can be a preferred stock) issued at a fixed interest rate with a specific maturity date. And at the option of the bondholder, it can be converted into a predetermined number of shares of stock of the issuing corporation. Holy moly, what a tongue-ful.

There are perhaps a thousand different convertible issues trading on various exchanges. Some are worthless; some are worthwhile; and some are worthy. There are three reasons so few brokers recommend convertible issues: 1) Their markets are thin and can't be profitably traded in billion-dollar blocks, so 2) brokerages' research departments ignore them. Therefore, 3) the commissions are niggardly, and salesmen have little incentive to recommend "converts" to their clients.

For illustrative purposes, only the following terribly simplistic explanation may help you understand how a convertible bond works. Assume Fleece-M Bank (FEMB-$10) needs to raise $100,000 in new capital. So FEMB hires Fishmore & DoLittle, a New York Stock Exchange brokerage, and, via an initial public offering, sells 100 bonds at $1,000 per bond with a 5 percent fixed interest rate, maturing in 2032. And to give this bond an edge among other 5 percent bonds, FEMB stipulates that it can be exchanged for or converted into 100 shares of FEMB stock at $10 per share, anytime the bondholder wishes, before it matures in 20 years. Now, if FEMB stock rises to $30 in 2019, the bondholder owns an asset worth $3,000 for which he paid $1,000 while earning 5 percent interest each year on his $1,000 investment. However, the owner can submit his convertible to FEMB in exchange for 100 common shares worth $3,000. But if FEMB stock falls from $10 to $5, it's foolish to convert into stock, because 100 shares are only worth $500. If the bondholder doesn't convert, he'll continue to earn $50 a year in interest and be paid the $1,000 face value at maturity in 2032.

Some investors contend that convertible bonds are preferable to common stocks because they provide the income and safety of a corporate bond with the appreciation potential of a common stock. Meanwhile, Vanguard, Fidelity, Nicholas-Applegate, Alger and Alliance are some of the larger mutual funds investing in convertible bonds. And if your broker can tear himself away from his office TV, he should be able to spy a few exchange-traded funds and closed-end funds whose portfolios own convertible securities. Then you can view their portfolios online and get a fair idea of what's out there in "convertible land." This is an excellent source for potential investments because these funds have researched those issues prior to owning them.

Value Line (VALU-$13) produces, publishes and markets investment-related data for the public, professional investors and institutions. And on the whole, its published historical information, balance sheet and income statement data, and narratives are sophomoric and basically worthless. Sales of its investment advice have crashed yearly since 2001, from $86 million in that year to $48 million last year, suggesting that professionals and investors hold VALU products in low regard. VALU won't send you a complimentary convertible issue (even an old one) because it is embarrassed by its content.

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Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775 or e-mail him at mjberko@yahoo.com. Visit Creators Syndicate website at www.creators.com.

© 2012 Creators Syndicate Inc.

Published: Fri, Aug 24, 2012

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