No. of Recommendations: 8
The following exercise must NOT be construed as a recommendation to buy. It is merely an exercise undertaken for the purposes of amusement.
The data is stale, but real, being the closing quotes as of Friday’s close for Ford Motor’s debt where the min purchase was one bond and YTM was at least 9%. How these prices will differ from Monday’s opening is any one’s guess. So the data is just data, and the exercise is just an exercise, meant to while away leisure time. Play along if you wish.

Issue Cpn Maturity YTM CY Price
FORD MTR CO DEL 6.500 08/01/18 9.57 7.92 82.090
FORD MTR CO DEL 9.215 09/15/21 10.62 10.17 90.625
FORD MTR CO DEL 8.875 01/15/22 10.28 9.82 90.350
FORD MTR CO DEL 7.125 11/15/25 9.88 9.12 78.090
FORD MTR CO DEL 7.500 08/01/26 10.30 9.63 77.850
FORD MTR CO DEL 6.625 02/15/28 9.67 8.94 74.125
FORD MTR CO DEL 6.375 02/01/29 9.27 8.59 74.225
FORD MTR CO DEL 7.450 07/16/31 9.04 8.77 84.997
FORD MTR CO DEL 8.900 01/15/32 10.28 10.12 87.975
FORD MTR CO DEL 7.750 06/15/43 10.64 10.52 73.689
FORD MTR CO DEL 7.400 11/01/46 9.69 9.60 77.100
FORD MTR CO DEL 9.980 02/15/47 10.94 10.93 91.350
FORD MTR CO DEL 7.700 05/15/97 10.43 10.43 73.850

Question: Which issue offers the best value?

Ford is in trouble, right? as is the whole US economy. But their prospects are improving, and to buy their debt is to make a bet on the future of the US economy. If you’re a whale in the investing world, you buy whole railroads. If you’re a minnow, you buy fractional shares of companies, or you lend them a bit of money. That’s how the purchase of corporate bonds should be viewed. Forget about prevailing interest-rates. (If you want to make bets on interest-rates, buy futures or some other appropriate vehicle.) If you want to be a lender to corporate America, pay attention first and foremost to the business to which you are lending and come to understand that business well enough to forecast its likelihood of survival. That means doing financial statement analysis, among other things.

For the purposes of this exercise, let’s assume we’ve done that part of our due diligence and we’ve concluded that Ford’s prospects are shaky, but that they might actually survive long well and well enough to pay interest and return principal. It’s far from a sure thing, but it’s possible, and to the extent that they are likely to fail is the size of the risk for which we are going to have to be paid to accept. In other words, if survival is a sure thing, we will settle for a low, but assured return. If survival is uncertain, but we want initiate a position, we need to get at a price that minimizes our risks. We might be wrong about the survival prospects of this company, but if we take a disciplined approach to our buying, and if we buy lots of companies, and if, over time, we are right more often than we are wrong, or right more often about the big things, then we will, on average, be profitable. So the strategy, as Buffet suggests, is just to not screw up too majorly. For a value investor, that means trying not to over-pay or over-buy.

Now back to Ford’s bonds: Which one offers the best value?

Your answer will likely differ from mine, and, likely, it won’t be wrong, because there’s a lot of ways to do this stuff. But here’s how I would go about trying to determine which bond to buy. Which bond is lowest in terms of price? Which bond is highest? What is the range of prices? If Ford files for Chapter 11 protection, the bondholders will likely be returned some value. It might be cash, new debt, or equity, or some combination thereof. But a haircut will be likely. To the extent that debt can be bought as close to a Chapter 11 workout price as possible (or even below that) is the extent to which one type of principal-risk can be reduced. But there is also an opposing dynamic that has to be considered. The longer the holding period, the more likely that BAD-Things-Will-Happen. However, that long-dated debt is typically the cheapest debt. So that becomes one trade-off to consider: a quicker maturity but a greater distance to a workout price versus a closer price to workout but a longer maturity.

Another trade-off to consider is cash-flow (also known as recovery-rate) versus price-appreciation. The faster one’s cash can be recovered, the faster one’s principal-risks are reduced, as well as one’s inflation risks. Therefore, a high current-yield might trump a high yield-to-maturity. It all depends on one’s purposes and which risks one most wishes to defend against.

And I’m sure there are other trade-off that other investors use when they evaluate bonds. But for me, those two trade-off’s are the biggies. I want to minimize the distance between my entry price and a Ch 11 workout price, and I want to maximize my recovery-rate. Everything else –-call-features, etc.-- is secondary. If a low price is also a cheap price when my reward: risk ratios are considered, then I’m a happy camper. If the bonds are expensive (when my reward risk ratios are considered), I’m not happy.

So, once again: Is any of Fords’ debt cheap?

The answer to that is a resounding “NO”. To see why, pull Time & Sales (T&S) for those bonds. A couple months back, any of those bonds could have been bought for a third of their present prices. By no stretch of the imagination is this debt presently cheap. And if the economy rolls over into a double dip, prices will fall again and a buyer would feel foolish for having “bought the high”. But there is also this to asked about present prices. How much of their increase is due to buying-demand prompted by prevailing interest-rates and how much is the rise in prices due to improving prospects for Ford? To the extent that the market correctly perceives that the risks of Ford’s debt have diminished, the increased price can simply be viewed as the cost of insurance. In other words, the removal of uncertainty is expensive. If you waited to buy Ford’s debt (instead of buying it when it was truly low priced), your wait is going to cost you potential profits. But your waiting might also help ensure you will actually achieve some profits to achieve. So that’s yet another trade-off: price-risk versus information-risk. (But digging into that topic is a post for another time.)

Again, let’s re-ask our basic question: Are any of Ford’s bonds worth buying? But let’s go about answering that question by asking the reversal: Which bonds in the list above are obviously bad buys?

The easy answer would be the longest-dated bond, the 7.7’s of ’97. But that would only be true if no other bond offered a better risk-reward profile. So let’s take a look at that bond and do some comparison-shopping. The bond is priced at 73 something and offers a 7.7 coupon. The nearest priced bond is 7/3/4’s of ’43. But notice this difference. The maturity is a whopping 54 years closer and offers nearly as much current-yield and yield-to-maturity. In fact, when inflation is taken into account, the YTM of the closer bond will prove superior in terms of return of purchasing power. (I’ll leave it to you as an exercise to do the discounting.) So, scratch that bond from the list. Then repeat this process throughout the whole list until you have identified for yourself where the “sweet spot” is (if there, in fact, is one), so that you arrive at the best possible combination of the factors that matter to you. If you do find a sweet spot in an issuer’s yield-curve, and if you are inclined to buy the issuer’s debt, then all that remains is to size your position and to execute your order.

Simple, right? It’s just shopping. No different than buying broccoli or bell peppers. The key to success is not over-paying and not over-buying. The key to not over-paying is to know your prices. The key to not over-buying is to buy in prudent sizes. The key to “prudent” is to not create positions so big that the damage from mistakes of judgment and from normal market reversals can’t be sustained without seriously impairing long-term financial goals.

Note: The preceding was merely an exercise. But running these kinds of exercises for yourself when you have the time to do them in a thoughtful manner means that you are putting into place skills that you can call upon when markets are open and prices are changing and execution speed might matter. Knowing how to invest well isn't a skill we are born with. Instead, it is a skill that has to be learned, and like all skills, acquiring competence requires practice. Whether you value the competence enough to undertake the practice is your own decision, as is viewing the practice as play to be done for its own sake on a rainy, Autumn afternoon when markets are closed but it's still too early in the day to head out for a walk.

Postscript: Broker-calculated YTM’s cannot be trusted. I accepted them at face value in this exercise. But when I’m doing my own evaluation work, I check the YTMs with my own procedures. The differences are often wide enough for me to find a bond attractive, or to argue against it. Will I buy some of Ford's debt Monday morning? I don't know yet, and I won't know, until I complete the exercise. What bought earlier in the year has done well for me. Whether the buying time is past is something I won't know until I've run the needed comparisons which involves two things: an analysis of Fords' yield-curve and then benchmarking that YC against those of all other issuers. I might find something worth buying. I might not. But I won't know for sure until I shop.
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No. of Recommendations: 1
I'll play.

7.75s of 43 for me if I'm buying.

Mix of attractive CY with high upside potential in the near-mid term when/if recovery is substantial leads to potentially a much higher YTM if improvement leads to selling before maturity.

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How would you estimate a "workout price"? tia
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You wrote, I'll play.

7.75s of 43 for me if I'm buying.

Mix of attractive CY with high upside potential in the near-mid term when/if recovery is substantial leads to potentially a much higher YTM if improvement leads to selling before maturity.

That's what I picked when I saw the list. Relatively speaking, I'd say that was the best value of the bunch.

I'm not sure how much up-side potential the issue really has - I'd think that was mostly a function of YTM and term to maturity. All of the issues' prices would tend to increase if Ford's prospects improve as their issues would fetch lower yields. But that particular issue has the lowest price-to-entry with the second highest CY and YTM. That minimizes my down-side risk while still optimizing my return.

Of course in some cases, the lowest price wouldn't be enough. But here the yields are close enough that the price was a dominate concern.

BTW, NYSE:KVU (Ford trust) is a better buy than any of these issues. With KVU's closing price of $18.95, the CY is 10.55% and the YTM is 10.93%. It also has a relative price of 75.8 per 100. It's already past its call date and it matures in 2031. The trust also holds senior notes, on par with these same bonds. Of course it's a thinly traded preferred and it only pays semiannually.

- Joel
Who holds 100 shares of KVU.
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Buying more of Ford’s debt would have meant extending my maturities. That isn’t something I’m reluctant to do on general principals. In fact, just the opposite is the case. The long-end of the yield-curve is often where the bargains are. But if maturities can be shortened up without sacrificing yield, why not do it?

Rather than add to my position in Ford’s Caa1/CCC+, typically long-dated debt, that is currently offering an average YTM of 10%, I added to two of my existing positions in other issues, and I initiated one new one. In all, I was able to knock about 25 years off what would have been my average maturity if I had bought Ford’s debt. I bumped up what would have been my credit-rating by one notch, and I increased what would have been my YTM by 180 basis points. So I did better by buying elsewhere this morning.

YTD, I have executed 62 bond buys, ranging in credit-quality from AAA to D, in maturity from 2 years to 37 years, in coupons from 0% to 12.4%, in price from 14.870 to 116.850, in current yield from 0% to 16.4%, in YTM from 5.3%% to 33.6%. In other words, I buy across the yield-curve and up and down the credit-spectrum. To date, I have had one call (that resulted in a windfall, 17.7% return), and I have suffered on Chapter 11 filing (causing a max loss of $151 and offering a likely, possible profit in the long run.)

If the position in default is included and the called bond is excluded, the average current- yield on my YTD buys is a modest 7.6%, and my YTM is an equally modest 12.0%. If those purchases are broken down into “credit-tiers”, the following schedule of names emerges:

-Top-tier Invest-grade (the triple-AAA’s. E.g., TVA)
-Upper-tier Invest-grade (the double-AA’s. E.g., Toyota, Berkshire)
-Lower-tier Invest-grade (the single-A’s, whether rated so officially or not. E.g., Cat, GE, Aflac)
-Bottom-tier Invest-grade (any triple-BBB, e.g., Alcoa, Anheuser, Arcelomittal, Time Warner, Weyerhaeuser)
-Upper-tier Spec-grade (the double-BB’s, e.g., Leucadia, Trinity, Sears)
-Lower-tier Spec-grade (the single-B’s and some triple-CCC’s. E.g., Ford, Hanson, Seagate, Smithfield, Wendy’s)
-Bottom-tier Spec-grade (anything rated less than Caa1 and CCC+. None. I typically don’t buy here.)
-Credit Limbo (i.e., anything in default. Reader’s Digest)

If a simple-minded bifurcation is established in which no bond rated less than Baa3 or BBB- by either agency is considered to be investment-grade, then my invest-grade bond purchases and spec-grade purchases show the following results.

Invest-grade--Average CY, 5.90%. Average YTM, 10.1%. Average YTD Price Gain, 15.1%.
Spec-grade----Average CY, 10.2%. Average YTM, 14.6%. Average YTD Price Gain, 18.3%.

Compared to bond funds with similar investment objectives, those results are an under-performance. But my numbers are what they are, and wishing they were otherwise doesn’t make them so. They are likely to met my long-term objective of moving purchasing-power forward to the future in a low-effort, relatively low-risk manner. So I have no regrets that I didn’t buy in larger sizes than I did, especially given present uncertainties as to the direction of the economy. My goal is simply to be a turtle that finishes the race, not the rabbit that puts on a good early performance but blows up before he reaches the finish line. If that sounds like defensive rationalization of my under-performance, it is. But “it ain’t over until it’s over”, and from where we are now with 10% unemployment and multi-trillion dollar deficits and debts, I’d rather err on the side of caution in my investing. Cheap money is fueling the current stock rally, as well as depressing bond yields. But that cheap money will have to be paid for down the road. That's when genuine bond bargains will become available again for those who still have a stash of cash.
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How would you estimate a "workout price"? tia


I'm not a Bk specialist, and I don't have access to the tools and info sources they use. So I make guesses based on two approaches: reports of historical recovery-rates based on the industry of the issuer and a discounting of their present balance sheet. In short, I make very rough guesses. I've experienced recovery-rates as high as 100% and as low as zero. A decent recovery is 30 cents on the dollar. But 20 cents (or lower) is a better figure to use.

What the game comes down to this this: if you buy the bond of an industrial in the mid-40's that has hard assets on its balance sheet, your likely downside is a lot less than buying some fluff-puff financial at 80. So if you can't figure out how they make their money or who might be a likely buyer of their assets, then don't take on the risks.

Here's another example, retailers. Typically, when a store goes under, its inventory is sold off at huge discounts, offering little money to pay the note-holders. (The banks and BK lawyers get it.) But if the store owns the land on which it sits, as opposed to leasing it, then it is sitting on assets that are typically carried on its books at "book value" which typically understates its present market worth. That positive difference between reported worth and actual worth creates a buffer for would-be bond buyers. E.g., I made a killing when K-Mart went under. OTOH, I lost everything when Warner Ladder filed. So gaming a company's assets isn't always easy. But the effort has to be made, because the risks have to be estimated.

Be careful out there in junk-bond word and best wishes, Charlie
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Good choice of exercise and very practical for myself given that I've been thinking about getting into some more shares of Ford for awhile. I feel more optimistic about them than I do for other companies with similar yielding bonds.

My tentative goal when I started expanding my bond holdings in August was to set up a 10 year bond ladder. My rationale for 10 years was that I did not feel comfortable predicting the fortunes of companies more than 10 years out.

Unfortunately, the bargains that are out there haven't always complied with my 10 years or less goal. Ford above is yet another example.

For my money (literally), the best choice is the 7.5 of 26. It comes at a decent discount (it was actually 76 yesterday)and the yield at around 10.5% is reasonably high. 2026 is a longer maturity than what I wanted, but it's not as ridiculous as something like 2097 would be.

Slowly, my 10 year bond ladder is becoming more of a 20 year bond ladder!
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