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|Subject: ATTN: Guys and Gals||Date: 1/24/2013 9:38 PM|
|Author: globalist2013||Number: 34721 of 35505|
Guys, and Gals,
My quick, off-the-cuff slam of Ducommun’s 9.75’s of ’18 in another thread does NOT deserve four recommendations for “Best Post”. It was a cheap shot at a very amateurish bond-picker. And I say that deliberately, because he introduced the bond to you without the least bit of evidence or argument that it might (or might not) make a good (or bad) investment. Instead, his post was a typical whine that, “Gees, things aren’t as easy as they used to be, and here’s a randomly chosen example of what I mean.” so, let’s dig into DCO's 9.75's of '18 a bit, and let’s see if we could use this bond to establish a process by which any bond could be evaluated. That’s the project that Blacktree should have undertaken for you, and that would be a post worth recommending.
With any bond you’re considering buying as a new investment, you need to forget about what anyone else has said about the issuer by way of a credit-rating, a stock report, etc. They aren’t buying the bond. You are, and you’re putting your own assets on the line. If you buy on their recommendation and the bond crashes, they aren’t going to call you up, say they’re sorry, and make good your losses. Your own due-diligence is what you will live by, or die by, in this investing business. So it’s up to you to determine the facts and their meaning. And this applies to *both* bonds and bond funds. An investment is an investment, no matter its structure, and you’re only going to get paid if you’ve gotten the facts right.
As one place to begin your due-diligence, any time you look at a bond, especially a bond with a high coupon (such as Ducommun has), you need to look at when the bond was issued and think back in your mind to what interest-rates prevailed at the time. In the case of DCO, the bond came to market 01/15/2012, or just over a year ago, meaning, this isn’t a classic, Ben Graham-style value play. It’s a f*ckin’ new-issue high-yield. That alone should scream a warning sign to you. Why does this company have to pay over-the-market rates to borrow money? Because it’s a piece of sh*t, sub-prime borrower. That’s all you need to know to reject this bond *unless* you’ve made it your business and specialization to invest in sub-prime debt. Period. Unless you have a disciplined method by which you can evaluate this kind of debt, you’ve got no business ever messing with Ducommun.
Next point. What would be the yield to you from buying this bond (assuming it doesn’t go belly up)? If you look at the quote line, you’ll see that the offering price for a minimum-purchase of five bonds is 112.540. On that basis, the broker –in this case, Zions Direct, because E*Trade wasn’t offering the bond-- calculates the YTM to be 6.949. But that is the YTM *before* commish, and there’s also an adverse call you’d need to be aware of. But let’s set aside both of those point and look at a far more serious problem. What would be the net-yield to you after taxes and inflation if you bought this bond? If you execute through ZD, your commish will be $9.95 per ticket. Back that into the offering-price, and you’re getting in at a premium to par I’ll leave to you to work out. But when you take that number and then subtract from it the present-day value of the principal that might be returned to you at maturity (as well as do the same with the income-stream for the coupons *and* pay taxes on gains), you’ll discover that you’re doing a ‘scratch trade’. In other words, if you apply your customary tax-rates and you use a probably low estimate of inflation at 5%, you’ll discover that buying Ducommun's bond gets you nowhere in terms of increasing your present-day purchasing power. NO WHERE. You haven’t made a penny more than you presently have. Meanwhile, you put your assets on line chasing a very risky situation. If that isn’t a good definition of financial insanity –-to say nothing of general stupidity-- then I don’t know what is.
Lastly, let’s consider a third point. You’d be getting into this bond at a price of roughly 112.709. That’s a long, long, long, long way from where a Chapter 11 workout-price will occur, which is exactly why you’ve gotta look at the company's balance sheet. If/when they do file Ch 11, your recovery-rate is going to be depend on the liquidating value of the issuer. Just how much value do you think accounting fluff like ‘Goodwill' and ‘Intangibles’ will have? What will 'plant’ and ‘inventory’ bring on the auction block? If you can’t determine a workout-value, you need to back way. If the value you determine is too far from your entry-price, you need to back away. If you can’t quantify *both* the likelihood of a Chapter 11 filing *and* the amount of the workout, then you need to *RUN* away. You’re screwing around with things you don’t understand, and you’re going to get hurt.
OK, it's gotten to be dinner time for me. So, I’m going to cut this short rather than grind through the couple dozen more points that need to be made. But you get the idea, and the idea is this. It don’t matter one bit what you’re buying. Stocks, bonds, bell peppers, or broccoli. The game is always the same. “What’s the price?” What’s the risks?” ”Are you being paid enough to accept them?” Clearly, in the case of DCO’s bond, there just isn’t a favorable risk/reward relationship. So, I’d pass, and my capital would survive another day. That's all this investing game is about, survival, a point that Buffet makes over and over again. "Just don't do anything too terribly stupid, and you'll make decent enough money." In summary, buying DCO's bond is a mistake better avoided. (IMHO, 'natch)
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